JULY 2010

Bond Strategies for Varying Goals

The strategies used for bond in-vesting will depend on the fi-

nancial objectives you are pursuing.Consider these financial objectivesand bond strategies:• Earning interest while preserv-

ing principal. This is the mosttypical role for bonds and is usu-ally accomplished with a buy-and-hold strategy. With thisstrategy, you purchase a bondand hold it to maturity, lookingfor the highest return potentialfor a given time frame within acomfortable risk level. By hold-ing the bond to maturity, youdon’t have to worry about inter-est rate changes impacting yourbond’s price. If an investor sellsthe bond prior to maturity, thereis a possibility of loss.

• Maximizing income. One wayto lock in higher yields is to buybonds with longer maturities, asthey typically have higher inter-est rates. Another strategy tohelp achieve this objective is toinvest in high-yield bonds, whichare bonds with lower credit rat-ings. Due to the lower credit rat-ing, these bonds often have tooffer higher interest rates to ob-tain investor interest. A thirdstrategy would be to purchasebonds priced at a premium.These bonds have higher couponrates and, thus, higher cash flowsthan bonds priced at par or at adiscount.

• Managing interest rate risk.

One of the most significant bondrisks is interest rate risk, or therisk that increases in interest rateswill cause a decrease in yourbond’s price. Bond ladders canhelp manage this risk. A bondladder is a portfolio of bonds ofsimilar amounts maturing in sev-eral different years. When one ofthe bonds matures, the principalis reinvested in another bond atthe bond ladder’s longest maturi-ty. By spreading out maturitydates, you lessen the impact ofinterest rate changes. Holdingthe bond to maturity eliminatesthe possibility of selling bonds ata loss. Since your bonds matureevery year or so, your principal is

reinvested over a period of timeinstead of in one lump sum. If interest rates rise, you have prin-cipal maturing every year or soto reinvest at higher rates. In adeclining interest rate market,you have locked in some funds inlonger-term bonds with higherinterest rates. But the main ad-vantage is you don’t continue tohold only short-term bonds whileyou wait for interest rates topeak, an event that is difficult topredict.

• Help reduce the volatility of stock investments. The advantage of including bothstocks and bonds in your

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Muni Bond Tips

Whether you’re just investigat-ing municipal bonds or are re-

viewing your current muni bondportfolio, consider the followingguidelines:• Compare the returns from mu-

nicipal bonds to other types ofbonds. Since the interest incomeis exempt from federal, andsometimes state and local, in-come taxes, your marginal taxbracket is a significant factor indeciding whether municipalbonds are appropriate for you.(Any capital gains are subject totaxes. Interest income for someinvestors may be subject to thealternative minimum tax.) Makesure to determine how a muni

FR2010-0323-0291

Financial Briefs

bond’s yield compares to theafter-tax yield on a comparabletaxable bond. To do that, calcu-late the tax-equivalent yield forthe municipal bond. If you’re notinvesting in a municipal bond is-sued within your resident state,which also exempts income fromstate and sometimes local incometaxes, the calculation is fairlystraightforward: the taxableequivalent yield equals the tax-exempt interest percentage divid-ed by one minus your marginaltax bracket.

• Don’t simply select the bondmaturity that offers the highestreturn. Since interest rate

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Bond Strategies Take a Look at TIPS

portfolio is that when one assetclass is declining, the other willhopefully help offset this decline.For instance, in 2008, the Stan-dard & Poor’s 500 (S&P 500) re-turned -37%, while long-termgovernment bonds returned25.9%, and intermediate-termgovernment bonds returned13.1%.* One way to assess thepercentage of bonds to include inyour portfolio is to look at howholding varying percentages ofstocks and bonds would have im-pacted your average return.

• Investing for a specific futuregoal. Because bonds have a defi-nite maturity date, you can selectmaturity dates to coincide withwhen you need your principal.You might want to consider zero-coupon bonds for this purpose.Zero-coupon bonds are issuedwith a deep discount from facevalue and do not pay interestduring the bond’s life. The re-turn results from the bond’s priceincreasing gradually from thediscounted value to face value,which is reached at maturity.The longer a zero-coupon bondhas until maturity, the greater itsprice discount will be. Like otherfixed-income investments, a zero-coupon’s price moves up wheninterest rates fall and down whenrates rise. However, since zeroslock in a fixed reinvestment rateof return, they are affected moredrastically by interest ratechanges. One important fact toconsider is taxation. Eventhough you do not receive anyinterest income until the zero-coupon bond matures, you maybe taxed on the yearly growth inthe zero’s value (called accre-tion).

• Recognizing a loss for tax pur-poses. A bond swap, which issimply the sale of one bond andthe purchase of another, can helpachieve this objective withoutchanging the basic compositionof your bond portfolio. Inessence, you sell a bond with a

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Perhaps you appreciate the ideaof including fixed-income in-

vestments in your portfolio, butyou do not like the thought of inflation chipping away at yourprincipal. If so, Treasury InflationProtected Securities (TIPS) may bea good option for you.

These Treasury bonds werecreated in 1997 to provide bond in-vestors with inflation protection byperiodically adjusting the bond’sface value based on the increase inthe Consumer Price Index for AllUrban Consumers (CPI-U). Thebond’s interest rate is determinedat auction and does not changeduring the bond’s life, but theprincipal is adjusted every sixmonths. Thus, subsequent interestpayments are based on the in-creased principal amount.

If the CPI-U decreases, yourprincipal will decrease, so thatyour interest payments will alsodecrease over time. However,when the bond matures, you willreceive the greater of the adjustedprincipal or the full face value.

From a tax standpoint, interestincome is subject to federal incometaxes but not state or local income

taxes. Also, any increases in thebond’s principal value is subject tofederal income taxes in the year theadjustment is made, even though thefunds aren’t received until the bondmatures. However, if the TIPS isheld in a tax-advantaged account,such as a 401(k) plan or individualretirement account, income taxes arenot paid until the funds are with-drawn. There is no guarantee thatinvestors will receive par if TIPS aresold prior to maturity.

To decide whether TIPS are abetter alternative than other Treasurysecurities, calculate the difference between the yield on a 10-year TIPSand a 10-year Treasury security. Asof June 21, 2010, that difference was1.98% (Source: Federal Reserve Statis-tical Release), which is considered thebreak-even rate. If inflation is higherthan 1.98% over the 10-year period,then the TIPS will have a higheryield than other Treasury securities.However, if inflation is lower than1.98% over the 10-year period, thenthe other Treasury security will havea higher yield than the TIPS.

Please call if you’d like to discuss TIPS in more detail. zxxx

FR2010-0323-0291

current market value less thanyour purchase price to realize aloss and deduct it on your tax re-turn. You then use the proceedsto purchase similar bonds. Theend result is that you still own acomparable bond, but you alsohave a tax loss. Review the costof the swap before executing thetransactions to ensure costs don’toffset most of your expected taxsavings. Make sure to complywith the wash sale rules or yourloss won’t be deductible. A washsale occurs when an investor sellsa security and within 30 days before or after, purchases a sub-stantially similar security. Bondspurchased within the 30-day win-dow must differ from the bondssold in a material way, which includes different issuers, couponrates, or maturity dates.

• Reducing income taxes. One

strategy would be to invest inmunicipal securities, since mu-nicipal bond interest is generallyexempt from federal, and some-times state and local, incometaxes. However, some investorsmay be subject to the alternativeminimum tax (AMT). See the ar-ticle, “Muni Bond Tips,” for moredetails.

Please call if you’d like help de-veloping bond strategies to pursueyour financial objectives. zxxx* Source: Stocks, Bonds, Bills, and Infla-tion 2010 Yearbook, Ibbotson Associates.The S&P 500 is an unmanaged indexgenerally considered representative ofthe U.S. stock market. Investors cannotinvest directly in an index. Past perfor-mance is not a guarantee of future results. Returns are presented for illus-trative purposes only and are not in-tended to project the performance of aspecific investment.

Muni Bond Tips

changes can significantly affectyour bond’s market value, it maymake more sense to select a ma-turity that coincides with whenyou need the principal.

• Look at a bond’s call provision.Most municipal bonds come witha call provision, which allows theissuer to redeem the bonds priorto their scheduled maturity.Calls are generally only exercisedwhen market interest rates arelower than the interest rate beingpaid on the bond and are gener-ally not good news for the bond-holder. Purchase bonds with callprovisions that are most favor-able to you.

• Review the bond’s credit quality. While municipal bonddefaults are rare, they do occur,so carefully review the creditquality of muni bonds. You maywant to stick with investment-grade ratings, which means thatthe issuer is considered financial-ly stable and unlikely to default.

• Hold a diversified portfolio.You should consider holdingseven to nine different issues tobe diversified. However, diversi-fication does not assure a profitor protect against loss.

• Consider bonds issued in yourresident state. Purchasing munibonds issued in the state inwhich you reside means thatyour interest income will also beexempt from state, and some-times local, income taxes.

• Review your holdings periodi-cally. Review the credit ratingsof all your municipal bonds atleast annually. Check the callprovisions so you aren’t sur-prised by a call in the comingyear. Also, review your holdingsto see that they are still consistentwith your overall investment ob-jectives and asset allocation plan.zxxx

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Copyright © Integrated Concepts 2010. Some information provided in this newsletter was prepared by Integrated Concepts. This newsletter in-tends to offer factual and up-to-date information on the subjects discussed, but should not be regarded as a complete analysis of these subjects.The appropriate professional advisers should be consulted before implementing any options presented. No party assumes liability for any loss ordamage resulting from errors or omissions or reliance on or use of this material.

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FR2010-0323-0291

Dealing with Bond Price Fluctuations

There are two primary factorsthat affect bond prices — in-

terest rate changes and credit rat-ing changes. Interest rate changestypically will cause a bond’s valueto fluctuate more than credit rat-ing changes.

As interest rates rise, a bond’sprice adjusts downward, while thebond’s price will increase whenrates decrease. Simply put, bondprices and interest rates move inopposite directions. Also, bondswith longer maturity dates aremore vulnerable to interest ratechanges, since the difference willimpact the bond for a longer timeperiod. One of the reasons longer-term bonds typically pay higherinterest rates is because there ismore risk that interest rates willchange during the bond’s life.

Credit ratings also influence abond’s price. When a bond is is-sued, rating agencies assign a rat-ing to give investors an indicationof the bond’s investment qualityand relative risk of default. Typi-cally, higher-rated bonds pay alower interest rate than lower-rated bonds. After the bond is is-sued, the rating agencies continueto monitor it, making changes ifwarranted. A bond’s price tendsto decline when a rating is down-graded and increase when a ratingis upgraded. The price changebrings the bond’s yield in line withother bonds with a similar rating.However, these price changes aretypically minor if the ratingchanges by only one notch. Cer-tain downgrades are more signifi-cant, such as a downgrade thatmoves a bond from an investmentgrade to a speculative rating, adowngrade of more than onenotch, and a series of downgrades

over a short period of time. Inthose situations, you should review your holdings to determinewhether you want to continue tohold the bond.

If you want to minimize therisk of price fluctuations, considerthese tips:• If you hold a bond to maturity,

you receive the full principalvalue, so you won’t be affectedby price fluctuations. Thus,consider purchasing bondswith maturity dates that matchyour investment time horizon.

• Consider investing in bondswith shorter-term maturities,which are less susceptible to in-terest rate changes.

• Design your bond portfoliousing a ladder, so you’ll havebonds coming due every yearor so. This strategy typicallylessens the effects of interestrate changes. Since the bondsare held to maturity, changinginterest rates won’t result in again or loss from a sale. Bondsare maturing every year or two,so your principal is reinvestedover a period of time instead ofin one lump sum. If interestrates rise, you have principalcoming due every year or so toreinvest at higher rates. In a de-clining interest rate environ-ment, you have some funds inlonger-term bonds with higherinterest rates.

• Choose bonds that match yourrisk tolerance. Safer bonds,such as U.S. Treasury bonds orinvestment-grade corporatebonds, are less susceptible tocredit rating risks.

Please call if you’d like to dis-cuss this topic in more detail. zxxx

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News and Announcements

From the Alexander HouseholdGive thanks for unknown blessings already on

their way. – Native American PrayerWhen I read this, I thought about how

much the saying takes for granted. It assumesthat we actually give thanks for blessings in ourlife — and that we recognize a blessing whenwe experience it. How often are we so busythat we don’t even notice the blessings, muchless give thanks?

And how often does something that didn’tinitially appear to be a blessing turn into one? Irecently agreed to teach an MBA financial plan-ning course at a local university. Although thetiming to teach the class wasn’t ideal andpreparing for the class took a considerableamount of time, it was an opportunity forgrowth, because I had never taught at the uni-versity level before. I was impressed by thededication of the students and found that Ienjoy teaching.

The saying also has optimism imbedded init by assuming that there are indeed unknownblessings already on the way to you. I don’tknow that the number of blessings changes, butI believe that my perception of how manyblessings there are in my life influences howmany I feel like I have experienced.

As you go through your day, look aroundyou for blessings and take time to give thanksfor them.

Carol Ringrose Alexander

From the Atwood HouseholdSummer is in full swing at the Atwood

household. I spent a full weekend preparingthe kids for camp. They both go to a Methodistcamp in Texas called Pine Cove every summer.They are in different groups because of ages, sothey both have different theme nights everynight. You have to get pretty creative with thethemes. Then with my son, it’s the balance be-tween creative and still being cool. They arenot allowed any electronics or phones. So theonly communication I get for that week is if

they mail me a letter. Savannah does, butChase never has. There is a website, however,that posts pictures every day. So, the week theyare gone, I peruse the photos to try and catch aglimpse of one of them and hope they lookhappy. They are always ready to go back, so Iknow that they have a blast. Once they areback, it’s all about catching up on laundry.

They have several other plans this summer,so I haven’t gotten the “I’m bored” or the“There is no food in the house” calls yet. Chasehas taken full responsibility for the lawn thissummer and has done a great job. Savannahhas been involved in some art classes at FrancisTuttle and produced some art pieces that areamazing. This is a great time of year for them,and I am so glad they are busy and getting todo so many things. All too quickly it will beabout school starting again.

Best wishes to you and yours!

Tracy Atwood, CFP, RFC

From the Bowie HouseholdI complained about it being wet and look

what we got…searing heat…I’m sorry, Lord!Family is doing great as we got three of ourhorses re-homed (down to two), and Janet de-cided to exit the cat-breeding business. It washer little project to make money to give away,but we constantly had people showing up atthe house to look and play. As of this letter,she’s finished, and her cats have been fixed.Now we just got to get rid of a few of her cats.

Our boys are on a mission trip to Kenyaagain…I stayed home this time. They love thecountry and the Kenyan people and were excit-ed to make another positive impact. Jared, ouryoungest, will be home in two weeks and thengoes abroad for a study program. Mommawasn’t happy that he’s asserting himself as anindependent adult…guess our baby has flownthe coop! All of our boys are doing well, andwe feel so blessed.

Take care!

Joe Bowie, CFP