Even the most novice of investors are likely to grasp the importance of fixed income assets during periods of market volatility. What may come as a surprise to many, however, is how versatile, varied and vibrant the fixed income space can be, and the role it plays in investing even beyond retirement planning, with which it is perhaps most commonly associated.
BNY Mellon Investment Management recently conducted a national research study that revealed the majority of Americans surveyed have limited understanding about fixed income investing—with only 8% of those surveyed able to identify the definition of fixed income investments. What the study underscored is a set of myths, misperceptions and misunderstandings that have settled around fixed income investing and are in thorough need of debunking, including:
- Certain investors don’t need fixed income: While nearly half of those surveyed (42%) reported having no exposure to fixed income investments, the asset class represents an integral component of any responsibly diversified portfolio, insofar as incorporating fixed income into portfolios generally helps reduce portfolio volatility, potentially enhances risk-adjusted returns and can provide peace of mind around mitigating downside risk.
- Fixed income is intended only for retirement planning: Contrary to the belief of 77% of survey respondents, fixed income is an important ingredient for a well-diversified portfolio regardless of an individual’s stage of life, as it may enhance overall risk-adjusted portfolio returns and lower volatility during difficult market periods.
- The best way to access fixed income is through individual bonds: The inclination of investors to own individual bonds may be a legacy of investing in municipal bond securities, which historically have been sold to retail investors on an issue-by-issue basis. While half (50%) of respondents still believe the best way to maximize value in portfolios is to own individual bonds, there may be appropriate times and reasons to consider building a fixed income allocation through individual bond issues.
- Equities require more knowledge and skill than fixed income: Stock selection is no easy task, but there is nothing simple about researching bond issuers and understanding the larger backdrop against which they operate. While 67% of those surveyed believe stock picking requires more skill, in reality, the value and number of U.S. debt securities far exceeds those of U.S. publicly traded stocks.
- Domestic bonds are always best: While more than half (59%) of Americans surveyed demonstrated a domestic bias in their belief that the U.S. market provides the best return potential for bond investors versus other countries, over 60% of bond opportunities originate from outside the U.S., offering investors many international opportunities.
- Municipal bonds are intended only for the wealthy: Said nearly 44% of survey participants, likely indicative of a somewhat dated view of tax-free bonds heavily sold to wealthy individuals subject to exceptionally high marginal tax rates. Today, there are a number of compelling reasons for all types of investors to consider municipal bonds, among them: lower default rates and reduced refinancing risks, less sensitivity to the interest rate environment and a feeling that one’s investment is making a (sometimes literal!) concrete impact.
- Rising interest rates are always bad for bondholders: Fixed income 101 is clear about the relationship between bond prices and yields (i.e., yields rise, bond prices fall and vice versa). In an environment of falling interest rates worldwide, however, rising rates might seem of little concern to investors and do not necessarily represent a significant long-term danger to bond investors
- Bonds must be held to maturity: Holders of bonds issued by GE, Lehman Brothers, Kodak and Sears (among others) very likely thought they owned bonds whose repayment was without doubt. A lot changes over a 10- or 20-year period, however, which can easily be the length of a bond’s full term. While nearly half (43%) of those surveyed believe they must hold a bond until it reaches maturity, amid a constantly changing interest rate and economic landscape—and in the face of unpredictable business fortunes—investors should consider whether the long haul is the right approach for them.
- Fixed income is always less liquid than equities: Given that stocks are considered highly liquid assets (i.e., easily convertible to cash at their intrinsic value), it’s no surprise that 61% of Americans surveyed believe that fixed income securities are less liquid than equities. Bonds occupy a wide swath of the liquidity spectrum, however, and, according to Bloomberg, the daily trading volume in the Treasury market alone has ranged from $500 billion to $1 trillion over the past 12 months.
- All bonds are created equal: To their credit, our survey showed that whatever their other misconceptions of fixed income may be, respondents understand that not all bonds share the same characteristics, with 70% of investors correctly identifying that all fixed income products do not provide the same level of risk and nearly nine in 10 (87%) recognizing all bonds do not provide the same level of income.
Though investors’ understanding of the fixed income space may be limited, the need for bonds in their portfolios should be an important consideration. Credit markets are not always easily understood; fixed income asset managers can help demystify this asset class for investors. When it comes to this most far-ranging and nimble of securities, it behooves investors to repeat this mantra: “fixed income, not fixed thinking.”
Liz Young is the director of market strategy at BNY Mellon Investment Management.
