As fixed income trading manager, Blerina helps construct and maintain customized bond portfolios, all with an eye toward finding the best way to implement the client’s comprehensive financial plan.
How Do Negative Interest Rates Actually Work And What Do They Mean For Your Portfolio?
Interest rates are one of several economic indicators to ‘go negative’ during the COVID-19 pandemic. Blerina Hysi explains what that means to our economy and our portfolios.
Transcript
Tim Maurer
Tim Maurer back with another episode of Ask Buckingham, a new video podcast designed to bring clarity in the midst of confusion by connecting your great personal finance questions with straightforward answers from industry thought leaders.
Today’s question will be answered by Blerina Hysi, fixed income trading manager at Buckingham Wealth Partners. And Blerina, we’re occasionally seeing headlines about bonds paying negative interest rates. What’s that all about?
Blerina Hysi
It sounds like a crazy concept, right? But it is happening. So basically we’ve seen that in treasuries … with treasuries, you have T-bills that are bought at a discount and they mature at par, and there is no interest payments throughout the life of that bond. And they’re usually short term. And then you have treasury notes that have a component to it. So, let’s look at a T-bill just to keep things simple. What’s happening with negative yields is that instead of buying these T-bills at a discount, you’re buying them above par. So, hypothetically speaking, you’re paying a 101 price for a T-bill. That means you’re paying a $1,010 per bond. At maturity, you’re only getting a thousand back. So that essentially gives you a negative yield because you’re paying more upfront to get less at the end.
Tim Maurer
Okay. So in terms of the mechanics here, we’re not necessarily talking about bond holders having to write a check to the bond issuer.
Blerina Hysi
Not necessarily. As you are spending the money upfront and you just don’t get it back at the end.
Tim Maurer
Okay. So is there a circumstance in which you would recommend someone purchasing a bond with a negative interest rate?
Blerina Hysi
No. For an individual investor, these don’t make sense. The reason why this is happening is you and I have the ability to go buy something else. We’re not restricted to buy these negative yields bonds, but if you’re a corporation, you cannot hold millions and millions of dollars at a bank. You are not FTSE insured. You’re not insured in any way. So, what you want to do is you want to have the insurance of the federal government and you really need to park money in these short term treasuries. In order to do so, you’re essentially just paying that negative yield, just to have the safety net to cover that money that you’re holding short term as a corporation.
Tim Maurer
Now that said, we have seen interest rates low and really low for, it seems like forever, but at this particular point in time with the flight to quality we are again seeing very low interest rates. What solace might you give us as investors who feel as though we’re beholden to hold instruments that are earning so little?
Blerina Hysi
You have to go back on what is the purpose of fixed income? Why do you hold fixed income in the first place? If you’re looking for yield, that’s fine, but do it where it makes the most sense, which is the equity side of your portfolio. Don’t look at fixed income to generate yield because it is there to dampen the volatility you’re taking on more risk investments. And once you start deteriorating the credit quality on fixed income, then what you’re going to see is in times like back in March where we saw the big volatility, your portfolio is going to behave the same. And that’s exactly what you want to avoid. Although interest rates are low, that fixed income portion is serving a purpose there and you just stick to that purpose.
Tim Maurer
Well, thank you so much for the reminder, Blerina. And thank you for tuning into this episode of Ask Buckingham. If you have a question that you’d like to see us address, you can do so by navigating to the website askbuckingham.com or by emailing your question to question@askbuckingham.com or just click in the corner of your screen right now, it will take you directly to the website.
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