The Role of Fixed Income in a Retirement Portfolio
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An Educational Guide for Individuals The role of fixed income in a retirement portfolio Fixed-income investments pay a fixed rate of return. This type of investment usually refers to government, corporate, or municipal bonds, which pay a fixed rate of interest until the bonds mature.1 Investors have traditionally held bond mutual funds2 in their portfolios for three reasons: interest income, diversification, and protection against an economic slowdown or deflation. Interest income Bonds that are the underlying investments in a mutual fund usually generate interest income on a set schedule (often quarterly, semian- nually, or annually). The interest income is usually reinvested in other bonds. Once interest dollars are reinvested, the bonds generate interest on interest. Interest on interest is a form of compounding, which can dramatically increase a bond portfolio’s total return (which includes both changes in the price of the bonds held, as well as the interest income generated by the bonds in the portfolio). Diversification – stock and bond investments Diversification means not “putting all of your eggs in one basket.” A stock market investor faces the risk that the stock market will decline and take the portfolio’s value down also. To offset this risk, investors have long turned to fixed-income investments because the perform- ance of stocks and bonds is often non-correlated; that is, market factors that are likely to have a negative impact on the performance (continued) Retirement Strategies of stocks may not necessarily have an impact on bonds. the income is paid to the investor or is reinvested, however, Bonds are generally considered a less volatile investment the attractiveness of the bond will vary based upon the level than stocks, and investors often include them in an effort to of income it generates during different economic times.) reduce some of the risk inherent in a stock-focused portfolio. When the prices of goods and services are rising (generally Although diversification does not ensure against loss, an during periods of economic growth), a bond’s income investor can diversify a portfolio across different asset becomes less attractive because that income buys fewer classes that perform independently in market cycles in an goods and services. On the other hand, slower economic effort to reduce the risk of low, or even negative, returns. growth usually leads to lower prices of goods and services, which makes bond income more attractive. An economic Protection against economic slowdown or deflation slowdown is also typically bad for corporate profits and Bond investments can help protect investors during an stock returns, adding to the attractiveness of bond income as economic slowdown for several reasons. The price of a bond a source of return. If the slowdown becomes bad enough that depends on how much investors value the interest income consumers stop buying things and prices in the economy that bonds provide. Most bonds pay a fixed interest amount begin to fall – a dire economic condition known as “defla- that doesn’t change. (Retirement plan investors do not tion” – then bond income becomes even more attractive receive actual interest income payments, but rather, the because one can buy more goods and services (due to their mutual fund reinvests the income in other bonds. Whether deflated prices) with the same amount of bond income. Bond prices and yields An important concept to understand regarding bond invest- ments is that a bond’s price always moves in the opposite The impact of interest rate changes direction to its yield, or rate of return, as illustrated in the diagram at right. The key to understanding this critical If interest rates rise… If interest rates fall… feature of the bond market is to recognize that a bond’s price Yields Prices reflects the value of the income that it provides through its Rise Rise Prices Yields regular interest payments (as explained in the previous Fall Fall section). When prevailing interest rates fall, existing bonds of all types become more valuable because they were issued in a higher interest rate environment and therefore have become less valuable (lower prices) because their yields higher interest income. Investors holding existing bonds are relatively lower than bonds issued at the current higher receive a “price premium” to sell them in the open market. rate, and existing bonds therefore trade at a “discount” to On the other hand, if interest rates rise, existing bonds may compensate the buyer for receiving less interest income. MassMutual Premier Fixed-Income Investments MassMutual offers a variety of fixed-income investments, most notably MassMutual’s Premier mutual funds, managed by Babson Capital Management LLC – a member of the MassMutual Financial Group and a recognized leader in the fixed-income marketplace. Consider the following investment options to complement your asset allocation strategy. Fixed-Income Investment Morningstar RatingTM 3 Investment Rationale (S share class) (as of 2/28/09) Premier Core Bond ★★★★3a This investment selects high-quality bonds with attractive yields (Babson Capital)2 and a prudent risk/reward trade-off. Total return is the result of the portfolio manager identifying the most Premier Diversified Bond ★★★3b 2 attractively priced sectors and securities, including U.S. denominated (Babson Capital) foreign and high-yield bonds. Inflation-indexed securities protect purchasing power by adjusting Premier Inflation-Protected Bond ★★★★3c for inflation, as measured by the Consumer Price Index (CPI). This (Babson Capital)2 investment provides protection of real purchasing power for income and principal by directly managing inflation risk. Premier High-Yield Bond ★★★★★3d This investment focuses solely on the identification of undervalued (Babson Capital)2 bonds that are poised for price appreciation. 1 Bonds are securities representing long-term debt issued by governments or corporations; the issuer pays interest on the bonds at specified dates and redeems them when the loan is scheduled to be repaid, called the maturity date. Fixed income also may refer to preferred stock that pays a fixed dividend. The information provided in this sheet focuses on bonds as fixed-income investments. 2 Plans either purchase shares of mutual funds or other similar investments directly, or they purchase units of separate investment accounts (“SIAs”) through a group annuity contract issued to a plan by MassMutual. Plans purchase units of SIAs; the SIAs, in turn, purchase shares of underlying mutual funds or other similar investments. 3 Morningstar is a widely known third-party provider of investment data and other services specific to the investments industry. For each fund with at least a three-year history, Morningstar Rating™ is based on a Morningstar risk-adjusted return measure that accounts for variation in a fund’s monthly performance (including the effects of sales charges, loads, and redemption fees), placing more emphasis on downward variations and rewarding consistent performance. These ratings change monthly. The top 10% of funds in an investment category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars, and the bottom 10% receive 1 star. The Overall Morningstar Rating for a fund is derived from a weighted average of the performance figures associated with its 3-year, 5-year, and 10-year (if applicable) Morningstar Ratings. 3a The fund was ranked among intermediate-term bond funds, receiving 3 stars out of 989 funds over 3 years, 4 stars out of 858 funds over 5 years, and 4 stars out of 461 funds over 10 years. 3b The fund was ranked among intermediate-term bond funds, receiving 3 stars out of 989 funds over 3 years, and 3 stars out of 858 funds over 5 years. 3c The fund was ranked among inflation-protected bond funds, receiving 3 stars out of 133 funds over 3 years, and 4 stars out of 64 funds over 5 years. 3d The fund was ranked among high-yield bond funds, receiving 5 stars out of 475 funds over 3 years, and 5 stars out of 401 funds over 5 years. If you have any questions regarding the information contained in this Update, please contact your MassMutual Retirement Services professional or call (877) 474-5496. Investors should consider an investment’s objectives, risks, charges and expenses carefully before investing. For this and other information, see the applicable prospectus, if an investment has a prospectus. Read it carefully before investing. You may obtain a prospectus by calling 1-888-309-3539. Securities offered through registered representatives of MML Investors Services, Inc., member FINRA and SIPC (www.finra.org and www.sipc.org), 1295 State Street, Springfield, MA 01111. © 2009 Massachusetts Mutual Life Insurance Company, Springfield, MA. All rights reserved. www.massmutual.com. RS4171 409 MassMutual Financial Group is a marketing name for Massachusetts Mutual Life Insurance Company (MassMutual) C:16686-00 [of which Retirement Services is a division] and its affiliated companies and sales representatives..