With interest rates poised to rise this year, bond investors may be tempted to wait things out. But trying to time the municipal market could come at a cost.
The Federal Reserve is expected to raise interest rates several more times this year. Since bond prices fall when interest rates rise, it is tempting for investors to either try to perfectly time their investments amid the anticipated rate increases or wait it out altogether and stay in cash. Trying to time the market isn’t a good plan for two reasons: it rarely works, and it is important to never lose sight of the main reason for investing in muni bonds — tax-exempt income.
Consistency is king
To illustrate the pros and cons of timing the municipal market versus staying invested, consider four scenarios, each assuming a $1,200 investment every year since 2000:
- Consistent investor: Consistently invested $100 each month.
- Lucky investor: Invested $1,200 during the best time each year — the month when the cumulative index total return was at its lowest point for that year.
- Unlucky investor: Invested $1,200 during the worst time each year — the month when the cumulative index total return was at its highest point for that year.
- Sideline investor: Stayed in cash.
The results demonstrate the value of staying invested, but more importantly, they marginalize the benefits of trying to predict the best entry points in any given year or market. The unlucky investor’s results are clear — a lower annualized return than either the lucky investor or the consistent investor. Perfect timing of the lucky investor’s annual $1,200 investment resulted in just under one-quarter of 1% more annualized return than the consistent investment approach over the entire 16-year period. Staying in cash yielded the worst result, lagging the consistent investor’s return by 3.5%.
Keep your eye on the prize
So with no discernable advantage to even perfect market timing (and the distinct possibility that trying to time the market will actually work against you), it is important to never lose sight of the main reason for investing in bonds — income. In 2016 when rates moved higher, the income component of the Bloomberg Barclays Municipal Bond Index equaled 1.96%, or 3.46% on an after-tax basis, for an investor in the top tax bracket. This tax-adjusted income return more than doubled the 1.71% price loss and provided a solid buffer in a period of rising rates.
It’s also important to remember that although prices of outstanding bonds will likely go down when rates start rising, the income stream for an investor who is continually staying invested will go up. Investors who understand these dynamics of the bond market will be more likely to stay the course and be there to capitalize on the inevitable highs that follow the lows.
Investors who stay the course and maintain a consistent investment approach are likely to fare better in the long run than those who try to predict the unpredictable. After all, the primary goal of fixed income is income, and to achieve consistent income you need to stay invested. Timing isn’t always everything.
Article by James Dearborn, Columbia Threadneedle Investments