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With interest rates on the rise, you might be wondering if you should be worried about the value of your bond portfolio.  Duration and a closely-related measure called convexity can help you find out…

Over the past six months, the benchmark rate on the 10-year Treasury note has risen from 1.4% to 2.4%. When interest rates rise, bond prices fall (and vice versa).  How much a particular bond’s price falls depends on two major factors: how much rates rise and the duration of the bond.

Duration measures how sensitive a bond’s price is to changes in interest rates.  The higher the duration, the higher the sensitivity.  If a bond you own has a duration of 4 and rates go up by 1%, its price will drop by approximately 4%.  If a bond I own has a duration of 6 and rates go up by 1%, its price will drop by approximately 6%.

It’s important to note that a drop in your bond’s price caused by a rise in interest rates isn’t all bad news.  Why is that the case?  The interest that the bond pays you at regular intervals (usually semiannually) can be reinvested at the new higher interest rate.

There are a number of bond characteristics that can affect its duration.  One such characteristic is the maturity of the bond.  As the maturity of the bond increases, its duration also increases.  Another characteristic is the coupon rate of the bond.  As the coupon rate increases, the duration of the bond decreases (and vice versa).

If duration is the bond-pricing Batman, then convexity would almost certainly play the part of Robin.  Oftentimes, duration alone isn’t enough to completely capture bond price movements caused by changes in interest rates.  In these cases, a convexity adjustment is used to fine-tune the price change estimate produced by duration alone.

Convexity is a favorable characteristic for a bond to have.  It causes the bond’s price to fall more slowly when interest rates rise and rise more quickly when interest rates fall.  As such, I highly recommend it!

This has been a very brief conceptual overview of bond duration and convexity.  Financial theory on the topics can get rather rigorous if you’re so inclined.  As always, if you have any questions about anything I’ve written here, please don’t hesitate to get in touch!

 

Note: This article was adapted from a presentation given to College for Financial Planning faculty members on February 7, 2017.

Brian Littlejohn is the Founder and CEO of Sherwood Investment Management, a fee-only financial advisor firm in Sonoma County, California.  Brian is a CERTIFIED FINANCIAL PLANNERTM professional who specializes in investment management.  He holds a MBA and a Master’s Degree in Financial Analysis.  He has over a decade of experience helping clients achieve their financial goals and occasionally teaches investing and financial planning courses as an adjunct professor.

Brian will begin teaching finance courses at the College for Financial Planning (https://www.cffp.edu/).  He is slated to teach a course on investment planning in July.  A preliminary topic outline is below:

Introduction to formula sheet and risk/return relationships
Types and measurements of risk, standard deviation, beta, and capital asset pricing model (CAPM)
Correlations and the “correlation pyramid”
Standard deviation of a portfolio, concept and calculation
Modern portfolio theory and application, capital market line (CML), security market line (SML), and asset allocation
Efficient market hypothesis (EMH) and behavioral finance
Zero, constant, and non-constant dividend discount model (DDM), valuation scenario
Risk/return measurements – Sharpe, Treynor, Jensen (alpha), beta reliability
Geometric, holding period, and dollar weighted returns, net present value (NPV)
Fundamental and technical analysis, ratios, anomalies
Features of fixed income, preferred stocks, convertibles
Bond calculations – TEY, CY, YTC, YTM, PV
Duration – concept and calculation, convexity
Derivatives – options, futures, warrants
Real assets – gold, real estate, property valuation, and various investment choices
Review

…you need a supercomputer to file your return: https://www.nytimes.com/2017/02/01/technology/ibm-watson-tax-return.html?_r=0

 

According to CBS News, the U.S. Tax Code is 70,000 pages.

For Immediate Release

Date: February 23, 2017
Contact:
Sherwood Investment Management
Brian Littlejohn
707.776.7331
brian@sherwoodim.com
www.sherwoodim.com

SHERWOOD INVESTMENT MANAGEMENT IMPLEMENTS AWARD-WINNING RISK ALIGNMENT PLATFORM TO DRIVE CLIENT SUCCESS

Petaluma, CA – Sherwood Investment Management announced it has implemented Riskalyze, the world’s first first risk alignment platform, which mathematically pinpoints a client’s Risk Number® and equips advisors to empower fearless investors.

Built on a Nobel Prize-winning framework, Riskalyze quantifies the semantics of the financial advice industry, replacing confusing and subjective terms like “moderately conservative” and “moderately aggressive” with the Risk Number, a number between 1 and 99 that pinpoints a client’s exact comfort zone for downside risk and potential upside gain. Advisors then build an investment portfolio to match the client’s Risk Number and chart a clearly defined path to the client’s goals.

Riskalyze was twice named one of the world’s 10 most innovative companies in finance by Fast Company Magazine and has appeared twice on the Forbes FinTech50 list.

“We look forward to using Riskalyze to provide our clients with enhanced risk clarity in their portfolios,” says Brian Littlejohn, Founder and CEO at Sherwood Investment Management.

“Sherwood has ushered in a new era of predictability and reliability for their clients by investing in the world’s first risk alignment platform to pinpoint a client’s Risk Number and align their portfolio to fit,” says Aaron Klein, CEO at Riskalyze. “We love working with advisory firms like Sherwood, who are committed to investing in the success of their clients by empowering fearless investing.”

About Sherwood Investment Management
Brian Littlejohn is the Founder and CEO of Sherwood Investment Management, a fee-only financial advisor firm in Sonoma County, California.  Brian is a CERTIFIED FINANCIAL PLANNERTM professional who specializes in investment management.  He holds a MBA and a Master’s Degree in Financial Analysis.  He has over a decade of experience helping clients achieve their financial goals and occasionally teaches investing and financial planning courses as an adjunct professor. To learn more, visit www.sherwoodim.com.

About Riskalyze
Riskalyze is the company that invented the Risk Number®, which powers the world’s first Risk Alignment Platform, empowers advisors to execute the digital advice business model with Autopilot and enables compliance teams to spot issues, develop real-time visibility and navigate changing fiduciary rules with Compliance Cloud. Advisors, broker-dealers, RIAs, asset managers, custodians and clearing firms use Riskalyze to align the world’s investments with each investor’s Risk Number. To learn more, visit www.riskalyze.com.

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http://www.investopedia.com/advisor-network/advisors/67739/brian-littlejohn-cfp-/

A sample of some of the Q&A you can find there is below:

User: Do lower interest rates increase investment spending?

Brian: Generally speaking, yes.  Lower interest rates mean that the cost of borrowing money is cheaper.  People/Corporations/Etc. borrow the cheaper money and invest it in all sorts of things.

User: Do mutual funds pay dividends or interest?

Brian: It depends on the mutual fund.  Some pay only dividends.  Some pay only interest.  Some pay both.

User: What are the risks of rolling my 401(k) into an annuity?

Brian: One risk to consider is interest rates.  If you go with an annuity now, chances are good that you’ll be locking in a relatively low interest rate.  Depending on the terms of the annuity, you may be stuck with receiving payments based on that lower rate for quite some time.

Beware!  Annuities can be tricky…be sure to read the fine print (or have a trusted advisor do so on your behalf).

 

Brian Littlejohn is the Founder and CEO of Sherwood Investment Management, a fee-only financial advisor firm in Sonoma County, California.  Brian is a CERTIFIED FINANCIAL PLANNERTM professional who specializes in investment management.  He holds a MBA and a Master’s Degree in Financial Analysis.  He has over a decade of experience helping clients achieve their financial goals and frequently teaches investing and financial planning courses as an adjunct professor.     

http://money.cnn.com/2016/09/08/investing/wells-fargo-created-phony-accounts-bank-fees/

http://www.rollingstone.com/politics/news/why-the-banks-should-be-broken-up-20160408

 

http://money.usnews.com/investing/articles/2016-07-14/how-to-set-up-an-online-brokerage-account

Brian Littlejohn is the Founder and CEO of Sherwood Investment Management, a fee-only financial advisor firm in Sonoma County, California.  Brian is a CERTIFIED FINANCIAL PLANNERTM professional who specializes in investment management.  He holds a MBA and a Master’s Degree in Financial Analysis.  He has over a decade of experience helping clients achieve their financial goals and frequently teaches investing and financial planning courses as an adjunct professor.