How To Build A Fixed Income Portfolio

If you are constantly worried about losing money in your investment portfolio it's probably because you don't trust yourself or the professional you hired to build your portfolio. Today I want to look at that part of your portfolio that should contain all the safe stuff to invest in. This is the fixed income part. The part that will not melt away completely in times of market mayhem and also provide some monthly income.

Professional fund managers agree on a 40% allocation in constructing a balanced portfolio. Matter of fact most balanced mutual funds are constructed the same way. Let's look at some of the ways we can divide up that 40% within the fixed income part.

I believe the proper approach when selecting bonds is to buy the whole bond market. It's just an idea to try and not for everyone. I have used this in the past and continue to use a hybrid approach in my wife's RRSP and LIRA. This passive approach works best to achieve efficient and expected market returns. You can then divide the bond portion into these four components achieving proper diversification within this asset class. Maybe try this;

• 10% government bonds – XGB
• 10% corporate bonds – XCB
• 10% real return bonds – XRB
• 10% high yield bonds – XHY

Total cost of bond portion of portfolio (MER) - .47 – Dividend Yield =3.24%

Total expected return of the fixed income portion of this portfolio would be 2.77% net of expenses.

You will own a total of 2,219 bonds. You will be well diversified but this will take some monitoring because of the higher risk posed by exposure to high yield US bonds.

OR

Another simple option is to buy XQB which is composed of 60% government and 40% corporate bonds. You would be leaving out the higher risk US bonds and the inflation protection of real return bonds.

40% - XQB

MER = .12, Yield = 2.58% - total return 2.46%

Total holdings of 324 bonds.

OR

40% - XBB

MER = .09 Yield = 2.95% - total return 2.87%

Total holding of 831 bonds.

OR

Another choice you have is to supplement your fixed income portion with a 5% weighting in cash and 5% in a preferred share ETF. This is my preferred way of incorporating fixed income into a portfolio.

5% - ZPR

MER = .50 = 3.89% - total return 3.39%

Total holding of 193 shares. These are preferential shares issued by many large companies, which act like bonds. Fixed dividend payments mean you always know the income to be received, and it comes in the form of dividends, so taxes are minimal and if invested and inside an RRSP deferred. Preferreds have shown virtually no volatility during the current market downturn in the TSX. Investors continue to collect their income through dividend distribution and will only pay half the tax a GIC generates, if you decide to invest outside of a sheltered account.

5% - Cash

GICs or HISAs

Whatever your bank has on offer.

The percentages here that I've divided up are just examples. You can use whatever you are comfortable with when putting together your own fixed income portion. I would still stick with the 40% weighting as it seems to work best when markets are falling to earth. Build your fixed income with whatever fund companies you want to use and whatever particular ETFs you like. I have no preference who or what funds one picks.

OR

Another strategy you could implement would be to diversify your risk between multiple ETF companies and change the percentage weightings. Mainly because you don't like too much of a corporate bond, high yield exposure and would like to hold cash. You might try this;

3% - XGB

5% - CBO

3% - ZRR

6% - CHB

18%- ZPR

5% - PSA - Purpose High Interest Savings ETF = 1.44% distribution yield

(you can purchase this on-line through a discount broker)

MER - .38 Yield = 3.4%

Whatever particular strategy you decide on, make sure you have at least 40% of your funds in fixed income to achieve a traditional balanced portfolio. Some cash, bonds and maybe some preferred shares. It will protect you and you'll be able to keep your head and get to sleep when the SHTF as it always does.

Related Post: The Greater Fool Balanced Portfolio

Recommended Reading: