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Your Investment Portfolio

Recession-Proofing It

Sunday, July 26, 2020

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It is probably not a stretch to say that the events of the past four months have dealt a significant blow to our finances. Lockdown saw us prowling around supermarket shelves more often than we'd previously been used to, and working from home even while home-schooling the kids have seen our funds incredibly falling prey to some weird Bermuda Triangle situation, especially if our income has seen a significant reduction. Even if we do not verbalise it the truth is there's quiet panicking going on in so many quarters when you're finding increasingly that your savings are being eaten into by daily expenses.

If there's anything this pandemic has shown us, it's the importance of a diversified investment portfolio, so that when the proverbial rainy day comes, you have a cushion and don't have to be downing anti-anxiety medication as though they are TicTacs.

In times of recession, let's face it: Job security is rocky. You might recall the explosion of taxis we witnessed after the global economic downturn of around 2008 (Jamaica Uber). This was largely as a result of newly out-of-work Jamaicans cashing out their severance cheques to make these investments. When the economy takes a downturn, businesses usually generate less revenue and profits, and depending on how long they envision being stuck in this holding pattern, it will affect the decisions they make regarding their spend, including salaries, and how this adversely affects their bottom line. This is why savvy investors need to watch carefully to see if the economic forecasts call for a recession.

As of now, economists are split on how far the current pandemic will propel world economies into recession. It will, for certain, bring on economic disruption, if not full-blown recession. In the event of an approaching recession or volatility on the market, how can investors ensure that they receive regular income and hedge the effect of interest rate fluctuations? Being proactive and creating a portfolio that sees an investment amount that is staggered among various bonds is a good way to go. This technique is called laddering (picture an actual ladder with its various rungs), which just means diversifying your bond portfolio of fixed income securities by significantly different maturity dates.

What's A Bond?

Bonds are different from stocks, in that, whereas stocks represent stakes of ownership in a company, referred to as shares, a bond however is a debt a company, government, or other entity, for a variety of reasons including raising capital for maintaining and expanding operations and product lines, enters into with an investor that pays the investor interest on the debt, at a fixed interest rate, which, upon maturity, the investor will get back the principal as well as the interest earned.

This makes bonds, which are available in major currencies, very desirable assets to own for short- or medium-term goals, in times of uncertainty in the economy especially for the risk-averse. They are lower-risk because they are impervious to interest rate fluctuations because they carry fixed interest (or coupon) rates on their loans and so don't usually depreciate in the same way stocks can. By staggering maturities of diverse, high-quality and non-callable bonds you can therefore create bond ladders and, as a result, a predictable stream of income. So, say you decide to invest equal amounts of money in five different bonds, how you would make sure you always have scheduled cash inflows is to invest in bonds that mature at different intervals over 10, 20, or, depending on your age, even 30 years.

Types Of Bonds

There are different issuers of bonds, some of which include:

• Treasury bonds, also known as government bonds, in which the bondholders lend money to a government.

• Corporate bonds, either high-quality, investment-grade bonds or low-quality/junk bonds, in which investors lend money to organisations

• Foreign bonds, which, as the name suggests, is where the issuer makes the fixed interest payments and returns the principal in another currency.

 

Of course you have the option of leaving your money in cash; this won't cause you to risk the kind of loss investments are capable of doing. It will nevertheless guarantee a loss to inflation. The aim is to earn money from different revenue streams during choppy financial times, which is what laddering does.

The biggest plus in laddering your investment is mitigating interest rate risk. Note, however, that certain bond prices can deteriorate if interest rates are cut, as they often are, in the eventuality of a recession. This would therefore mean that short-duration bonds might be the best way to go, since they will mature quicker, but may not earn you as much interest. As with any investment, there must be a careful examination of bond strategies.

While we know markets always abound even if we can't predict the exact time they will do so, and that recessions are not to be feared, as they can provide the opportunity for personal development, a diversified bond ladder, while not guaranteeing complete avoidance of a loss, nevertheless, can significantly protect investors by helping to manage the risk attached to any single investment.


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