Investment Basics: Style Box Investing

Contributed by: Nicholas Boguth

Among the plethora of data points used to describe any security, there are two that are fundamental for a basic understanding of  stocks and bonds. For equities, the two pieces of data are market capitalization (size) and investment style (value/growth). For fixed income securities, the data points are interest rate sensitivity (duration) and credit quality.  These characteristics are important parts of every security’s risk/return profile, and are key in determining if and how an investment should fit in your portfolio.

In order to help investors easily identify these two key characteristics of securities, Morningstar created a useful tool – the style box. There is a separate box for equities and fixed income securities. The equity style box shows value to growth investment styles on the horizontal axis and small to large market caps on the vertical axis.  For fixed income, the horizontal axis shows limited to extensive interest rate sensitivity and the vertical axis shows low to high credit quality.

As investors, the first decision you have to make is to determine your capacity for risk. Once determined, you are able to choose investments that align with the level of risk you are willing to take.  Growth stocks typically carry more risk than value stocks, and small-cap stocks are usually riskier than large-cap.  Bonds can have limited to extensive interest rate risk based on duration (longer duration = more interest rate risk), and a bond with low credit quality is normally riskier than one with high credit quality.  Looking at the style box, this means that a security that falls in the bottom-right square will typically bear more risk (and hopefully opportunity for more return), and a security that falls in the top left box will typically have less risk. 

The style box is especially useful because not only does it indicate those fundamental data points of a single security, but you can plot all your investments on it to see the characteristics of your entire portfolio as well.   Not every individual security chosen for your portfolio has to match your exact risk profile.  In fact, when you build a portfolio, you may diversify and end up with securities that scatter all over the style box.  The suitability of investments refers to your portfolio as a whole, not individual investments, so it is acceptable to have some lower risk and some higher risk securities.  That being said, the style box does not operate on tic-tac-toe-like rules where a diversified portfolio is one with all of the boxes checked off.  It does not explain everything there is to know about a diversified portfolio, but it is a very useful tool that is essential to investment basics.

Nicholas Boguth is a Client Service Associate at Center for Financial Planning, Inc.

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This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Any opinions are those of Nick Boguth and not necessarily those of Raymond James. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Investing involves risk and investors may incur a profit or a loss regardless of strategy selected. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Diversification and asset allocation do not ensure a profit or protect against a loss. Investments mentioned may not be suitable for all investors. Past performance is not a guarantee of future results.

Investment Basics: Bonds 101

Contributed by: Nicholas Boguth

Bonds are a hot topic in the investment community today while we patiently await a rise in interest rates from the Fed. We know that interest rates affect the bond market, but how? In order to truly gain a better understanding of how the bond market works, we’re going back to the basics to address some important fundamental questions that all investors should understand.

First off, what is a bond?

A bond is a debt instrument that a company or government uses to borrow money. A corporation may need cash in order to build new factories; a government may need cash to build a bridge, etc. In order to borrow money, they sell you (the investor) a bond that basically says, “We owe you.” By selling these bonds, they are able raise a large amount of cash, and pay it back over time.

It is important to note that the major difference between bonds and stocks is that bonds are debt, and stocks are equity. If you own a bond, you own a portion of the issuer’s debt. If you own a stock, you own a portion of the company. The upside of owning a bond is that you receive back principal plus interest; you have higher priority for getting paid if the issuer goes bankrupt, and you don’t lose money because the stock price declines. The downside is that you don’t share the issuer’s future profits or participate in rising stock prices. These factors are why bonds are typically considered “less volatile” investments.

What is a coupon?

Bonds pay interest to you, the investor. A coupon is simply the amount of money that you receive at each interest payment (typically every six months). Par value, or the issuer’s price of a bond, is typically $1000. If a bond has a 5% coupon, then you receive 5% of $1000 every year; or $25 every 6 months.

What is yield?

A bond’s yield is a measure of its return. Current yield is calculated by taking the coupon payment and dividing by the current price of the bond. When a bond is trading at par, rather than at a discount or premium, the yield is equal to the coupon payment: $50 coupon payment/$1000 bond price = 5% yield. If the price of that same bond rose to $2000, then the current yield would be $50/$2000 = 2.5%. The yield is lower because you had to pay more money for the bond. The opposite would be true if you bought the bond at a discount. The Yield to maturity is another measure of return. It reflects the return you would get if you held the bond all the way to maturity. For you investors, it is important to understand what coupons and yields are in order to understand their relationship to pricing and interest rate changes.

Why do bond prices go down when interest rates go up?

When interest rates rise, new bonds that are being issued will have higher coupon payments than the old bonds that were issued in the lower interest rate environment. Why would anyone ever buy one of those old bonds that have smaller coupons? If they were the same price, they wouldn’t! This is why bond prices fall when interest rates rise. In order for the yield to be equal between the bond with the higher coupon and the bond with the smaller coupon, the bond with the smaller coupon would have to be cheaper.

Nicholas Boguth is a Client Service Associate at Center for Financial Planning, Inc.

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This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Nick Boguth and not necessarily those of Raymond James. Investments mentioned may not be suitable for all investors. Investing involves risk and investors may incur a profit or a loss. The hypothetical examples are for illustration purpose only and do not represent an actual investment.

There are special risks associated with investing with bonds such as interest rate risk, market risk, call risk, prepayment risk, credit risk, reinvestment risk, and unique tax consequences. To learn more about these risks and the suitability of these bonds for you, please contact our office.

New Investor Access Tool: Account Aggregation

Contributed by: Nicholas Boguth

Investor Access has just added a neat new feature to the platform that allows you to organize your accounts so that they are easier to keep track of on the website.  If you are a subscriber to Investor Access, you are now able to create groups of accounts and aggregate them to different categories.  If you are not signed up for Investor Access, now is a good time to try it. You can take advantage of this feature in many ways, but here are a few ideas and examples to help you organize your accounts:

• Cluster accounts by account owner and/or by account type
• Separate your cash accounts from investment accounts
• Separate your savings accounts from your checking accounts
• Group your retirement accounts together
• Group your individual or trading accounts together

However you choose to use this tool, it should make managing and maintaining your accounts a little easier with better organization.

CLICK HERE for more detailed instructions on how to take advantage of this new feature.

If you are not familiar with Investor Access, follow the “Investor Access” link at the top of our website to find out more.  And as always, please contact any of our Center Client Service Associates with any questions!

Nicholas Boguth is an Investment Research Associate at Center for Financial Planning, Inc.