A deep dive into fixed income asset allocation

Scott A. Hansen, BridgeTower Media Newswires

To dive into fixed income asset allocation, first let’s break this into two pieces:

Fixed income

How well do you really know fixed income? Many of our clients would tell you that it’s a ladder of bonds, yet the full answer may surprise you. Fixed income by definition includes much more than just bonds — let’s dive into its many channels together.

Any stream of income that is received on a regular basis, and usually in the same amount, is by definition fixed income. For example, a pension is a draw of income on a regular basis to support the investor’s retirement lifestyle. A pension can be either employment-based, social- and state- based or based upon some form of disability.

Other streams of income that should be included into the investors allocation to fixed income would be income from rental property, Social Security payments, settlements from legal action, alimony received and even dividends received from certain types of investments.

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Asset allocation

Most of you will have a handle on this term. It’s basically how you’ve divvied up your “eggs” into your baskets, right? Let’s have a look.

Asset allocation is defined as the implementation of an investment strategy that attempts to balance risk versus reward. It does this by adjusting the percentage of each asset in an investment portfolio according to the investor’s risk tolerance, goals, investment time frame and the expected future performance of each asset class. The focus is on the characteristics of the overall portfolio. For most portfolios, that will include an equity allocation. This usually contains large-cap growth and value, small and mid-cap, and international equities: both emerging market and established market companies.

The majority of investment portfolios will also include some allocation to fixed income.

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Bringing it together: fixed income asset allocation

For the common fixed income investor, allocation to the fixed income asset class means a varied ladder of bonds or bond funds with differing duration and credit quality, in order to create an income stream and balance the risk of the equity portion of the portfolio. The mistake that investors make is not factoring in other income from such things as rental property, Social Security payments, settlements from legal action, alimony received and even dividends (if a large enough amount) as part of their strategy. If such payments are regular in timing and similar in amount, then they should be calculated as a portion of the fixed income for the portfolio.

Depending on the stage in life of the investor, that income stream can be a defining factor in their standard of living. However, when looking into the allocation to fixed income, investors can fail to include other sources of income to this asset class, thus throwing their entire asset allocation strategy off. This could mean that the investor can have a larger allocation to fixed income than they realize and as a result, they may be under-allocating to the growth portion of their portfolio. The key issue is that if growth is under-allocated in the portfolio, then key family goals may not be met — which can lead to unmet retirement goals and a failed strategy.

To tie this all together: It is essential to include all types of fixed income into the planning of any investment strategy with a trusted advisor. Leaving anything outside the plan can have potential dramatic effects on the outcome and have an impact on standard of living later in life. That is an outcome that no investor wants to face.

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A. Scott Hansen is a vice president for Karpus Investment Management,Florida Office, a local independent, registered investment advisor managing assets for individuals, corporations, non-profits and trustees.  Offices are located at 183 Sully’s Trail, Pittsford, NY 14534, phone (585) 586-4680.

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