How to Construct Your Fixed-Income Portfolio
This column was originally published on RealMoney on March 30 at 10:33 a.m. EDT. It's being republished as a bonus for TheStreet.com readers. For more information about subscribing to RealMoney, please click here.
Lately, several readers have asked about fixed-income portfolio construction. The nuts and bolts of this do not get discussed very often, and while I don't have all the answers by any means, a look over my shoulder might be worthwhile for some folks.
As with equity investing, it makes sense to capture different segments of the market and be willing to use different tools to get the job done.
Reducing Volatility, Adding Yield
Most people think about owning bonds for the income, and this is valid, but fixed-income instruments can also reduce volatility and add a little yield to the overall portfolio, even if there is no intention of taking income out. This could reduce returns somewhat, but it also reduces volatility, and that will appeal to some investors.Usually the heaviest weighting will go to U.S. Treasuries -- roughly 35% of the fixed-income portion of the portfolio. For now, with the yield curve somewhere between flat and inverted, it makes sense to keep maturities short. I think the likelihood that the yield curve normalizes in the next year or two, pushing intermediate rates up to something closer to the historical norm, is very high. I would rather lock in 4.9% for a year for the chance to earn more on a five-year Treasury note 12 or 18 months from now. However, funds or ETFs that buy Treasuries would not be my first choice, because Treasuries are very liquid and can be purchased in small amounts, and there is no reasonable issuer risk taken in this market. For clients for whom municipal bonds are appropriate, I would own them, again preferably individual issues, in lieu of Treasuries.
Some Inside TIPSThe second-largest allocation -- 20% -- within the fixed-income portfolio is the inflation-protected segment, where I prefer the iShares Lehman TIPS Bond ETF (TIP). Choosing an ETF instead of individual issues is debatable, but I find ETFs easier to access, and given the low yields in this segment, I believe that capturing most of the effect in a similar manner is best for those who are not taking income.
Select the service that is right for you!COMPARE ALL SERVICES
Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.
- $2.5+ million portfolio
- Large-cap and dividend focus
- Intraday trade alerts from Cramer
- Weekly roundups
Access the tool that DOMINATES the Russell 2000 and the S&P 500.
- Buy, hold, or sell recommendations for over 4,300 stocks
- Unlimited research reports on your favorite stocks
- A custom stock screener
- Upgrade/downgrade alerts
Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.
- Diversified model portfolio of dividend stocks
- Alerts when market news affect the portfolio
- Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.
- Real Money + Doug Kass + 15 more Wall Street Pros
- Intraday commentary & news
- Ultra-actionable trading ideas
Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.
- 100+ monthly options trading ideas
- Actionable options commentary & news
- Real-time trading community
- Options TV