It ’ s Your Money
Fixed Income Investing ( Part 1 )
By Mark J . Funt DMD , MBA
So far in this series , I have generally written about investing in equities ( stocks ). In this piece , I am going to begin the discussion on fixed income investing . Fixed income runs the gamut from risk free , very short-term savings / money market accounts , to very risky long-term bond investing and everything in between .
The bond market , a very large part of the fixed income market , is a market no different than the stock market . Prices on bonds , like stocks , fluctuate on an intra and inter day basis . As a matter of fact , some people buy bonds like they do stocks , in hopes of capturing capital appreciation as well as a fixed rate of return . Bonds come in all shapes and sizes . There are ultra-short , short , intermediate and long-term bonds . There are zero coupon , savings and Build America Bonds . There are low , medium and high quality bonds , taxable and tax free bonds , very safe and very risky bonds as well as low and high yielding bonds . Just like stocks , the bigger the risk you take in bond investing , the greater the potential return . The yield on bonds is generally based on the past and present interest rates , the year of maturity as well as the credit quality of the issuer of the bond . Bonds can be bought at par , at a premium or a discount , the details of which will be explained in a future article .
In order to be a serious bond investor , you need to have some understanding of the economy and how fiscal and monetary policy affects the economy , as well as how the economy affects interest rates . As always , I will try to explain these factors in an over-simplified manner . The first thing you need to know is that the economy goes through natural cycles of booms and busts . There are periods of economic growth and economic slowdowns that can lead to recessions and even depressions . After 6-7 years of economic growth , the economy slipped into a recession , which is defined as two consecutive quarters of negative GDP ( Gross Domestic Product ). Due to a series of several very unfortunate economic mishaps , which I have written about in previous articles , this recession is much worse than previous ones . In many cases , the strength of the economic expansions and severity of the economic downturns has to do with how well the economy is managed by the federal government . The truth of the matter is that the President of the United States has very little control over the success and failure of the economy , although he will get the blame when the economy is failing and the credit when it is strong . The president , with approval of Congress , can only do two things in controlling fiscal policy — increase or decrease governmental spending and / or increase or decrease taxes . The Bush administration opted to lower taxes whereas the Obama administration opted to increase government spending . Some would question whether spending money the government does not have is a good idea to try to get us out of a recession , but time will tell who is and isn ’ t correct . The much more powerful branch of the government is the Federal Reserve Board , the body that controls monetary policy . Although the Federal Reserve Chairman is appointed by the President and approved by the Congress , at this point the Federal Reserve is completely independent and autonomous from the executive and legislative branches of the government . The Federal Reserve has many tools at its disposal on how to accomplish its goals of keeping the economy growing at a healthy pace and keeping inflation low , a daunting task to say the least .
The most powerful tool the Fed has is to lower or raise interest rates . The Fed tries to stay ahead of the curve and be proactive with its monetary policy . However , like the stock market , the Fed often goes too far , too fast or too slow in accomplishing its goals , causing bubbles in the economy . As I previously stated , besides promoting economic growth , the Fed is very concerned about controlling inflation . Inflation is simply defined as too many dollars chasing too few goods . This is a simple supply and demand equation . If lots of people have lots of money to spend , businesses will increase the price of their goods and services . A perfect example is the recent housing bubble . As the Fed lowered interest rates , more and more people could get loans as money became more available and the prices of homes “ literally ” went through the roof . Of course , one of the causes of our present economic tsunami is that the banks gave loans to people who could never afford to pay them back . Many people blame Alan Greenspan ( the former Fed chairman ) for lowering rates too low too fast , creating the housing bubble . However , as bad as inflation is , the Fed is much more concerned about deflation . Deflation is defined as a decrease in prices . Deflation is more destructive to the economy then inflation . If businesses have to lower prices , this will cut into their profits and may mean layoffs
September / October 2010 • Pennsylvania Dental Journal
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