With interest rates reaching a 40-year low, many bondholders may need to decide what to do with the cash they receive if their bonds are called or reach maturity. Many bond issuers are still taking advantage of lingering low interest rates by calling outstanding bonds and offering new issues at much lower rates. As a result, bond investors must determine what to do with their newly acquired cash. They have many options available, such as investing in the stock market, purchasing new bonds most likely at lower interest rates or holding the cash. So what should a bondholder faced with this question consider?
Before investing, many investors try to predict the top or bottom of the stock or bond market, which is usually not a good idea. When you try to predict a market bottom, or top for that matter, you may run the risk of buying high and selling when the market is trading low - opposite of what you want to achieve. Remaining constantly invested and well-diversified can help cushion the market's often-rocky bottom.
Holding cash instead of investing can also be a costly mistake. Chances are you have had a certain percentage of your portfolio allocated to fixed-income instruments such as bonds or CDs for good reason. These types of investments not only provide income but also preserve principle. So if your bonds are called and you receive cash, it may be necessary to reinvest in bonds to maintain that balance and diversification. But if that is the course you take, it's important to try to reinvest quickly because every day that you're not invested is a day that you may be missing out on accrued interest. While you may experience a situation in which you aren't receiving as much interest as you're used to receiving, it's better than missing out on that interest income altogether.
While the Fed is expected to keep rates low in the near term, no one can predict when rates might rise. With that in mind, you may want to stay away from long-term fixed-income investments and stick with short- and intermediate-term bonds. That way, you won't be caught with undesirable rates should better alternatives become available.
When redeeming your bonds, you may also want to work with your financial consultant to rebalance your portfolio. Because of fluctuations in both the stock and bond markets, the percentage of your assets allocated to each category (stocks, bonds and cash) has most likely changed. Or maybe you've come to a point in your life when your objectives or risk tolerances have changed. As a result, you may find it necessary to adjust your investments accordingly or find a new way for bonds to fit into your portfolio.
Talk with your financial consultant for more information about bond redemptions or how bonds can fit into your portfolio. He or she can work with you to find the best strategy to help you meet your financial goals.
Editor's note: Jay Torgerson is a financial consultant and accredited asset management specialist with AG Edwards & Sons in Salem. Questions and comments can be directed to him at (503) 881-5353.