Investors who've seen their bond securities balloon in value have to weigh multiple issues
Some fixed-income investors who’ve held their funds or bond securities for at least six months may be sitting on a sizeable capital gain, driven in part by drastic reductions in interest rates enacted by central banks looking to support their respective economies. The question is: what should they do with it?
Many may say their first instinct is to book those gains. But as a recent piece on the Wall Street Journal noted, that may not be the best choice.
For one thing, taking profits on those funds would mean more risk for income-seeking bond investors. Because of the drastic reductions in rates in recent months, bond yields have gotten depressed, and anyone who wishes to maintain the same level of yield from newly bought bonds would have to target longer maturities or weaker credit profiles.
Another sticking point, particularly for those holding their bonds or bond funds in a taxable account, is the tax hit they’d sustain from the capital gains. For those living in a high-tax jurisdiction or bracket, that could mean replacing the bond holdings they sold with higher-yield bonds or another high-return asset to mitigate the tax hit – again, resulting in increased risk.
But in some cases, the chance to crystallize profits from higher bond values could be a welcome opportunity. If the portfolio as it stands is too risky for an investor’s liking, they could shift to safer options.
“If you have concerns about safety issues, this is an opportunity to de-risk—perhaps from high-yield [junk bonds] to Treasurys,” Andy Schuler, head of PNC Wealth Management’s investment program told the Journal.
Those who consider their current yields too meagre may also want to sell their already-safe holdings and diversify into slightly riskier bonds – from Treasurys to investment-grade corporate bonds, for example. Those with the financial wherewithal may even consider taking on a touch of high-yield bonds, making sure that they’re part of a diversified bond portfolio.
Some might also consider wading into dividend-paying stocks. But the price of that higher expected income would be a decrease in portfolio ballast, which might not be the best option for the safety-minded investor.
Another play that might cross some investors’ minds is to sell their profitable bonds, and stay in cash until interest rates rise enough to allow acceptable yields on bonds. But as Collin Martin, a fixed-income strategist at Charles Schwab said, the lower-for-longer outlook on interest rates is not likely to change anytime soon.
“The Fed has indicated short-term rates will likely be near zero for 2½ years or more,” he said. “Given this environment, if everything you own is a high-quality investment, there probably aren’t moves you need to make.”