Maximizing Fixed Income Investments

In the world of investing, the concern for most individuals is market risk—the volatility (or risk) that comes from investing in equities.  To limit the risk often associated with the equity market, many individuals invest in an assortment of fixed income investments such as CDs, term notes, or bonds.  While this approach can reduce one’s exposure to market risk, it does open the door to a less-talked-about kind of risk—reinvestment risk. 

Reinvestment risk refers to the possibility that, at maturity, an initial income investment may not be able to be reinvested at the same rate of return.  An example of this can be taken from the late 1990s when, due to a strong economy, it was not uncommon to have a fixed income investment paying 7-8 percent.  If that investment had matured in 2001-2003, it would most likely have been reinvested at 2-3 percent, a much lower rate of return due to the weakened economy.  A rate of return loss that large could be a major adjustment to someone living on a fixed income.  One strategy used to help avoid reinvestment risk is a laddered portfolio. 

A laddered portfolio strategy staggers the maturity dates of investments.  An example of a short-term laddered portfolio would be investments in 6-month, 12-month, and 18-month products.  As the 6-month product matures, it would be reinvested into another 18-month product.  The same thing would happen after the 12-month matured.  The benefits of this strategy include access to some principal every 6 months; and after 12 months, all holdings are invested in an 18-month investment which typically has a higher rate of return. 

Bob Lamb, CFP®
SVP Investment and Retirement Solutions
AG Financial Solutions