4 QUESTIONS YOU NEED TO ASK ABOUT INCOME INVESTING

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1 4 QUESTIONS YOU NEED TO ASK ABOUT INCOME INVESTING Understanding risks // Evaluating your portfolio // Taking action INTRODUCTION The markets present investors with challenges interest rate and credit risks in particular that should be considered when evaluating income-producing investments. Rising interest rates in the future can have a dramatic impact on the value of these investments, but there are strategies available to help you manage those risks. It s important to understand which types of risk you are more comfortable with, as there are tradeoffs with every decision you make in your portfolio. When you meet with your financial advisor to discuss these realities of income investing, be sure to address these four key questions: 1 u 2 u 3 u 4 u What do I own and why what role do income-producing securities play in my portfolio? What will happen to my portfolio when interest rates rise? What other risks am I exposed to? What action should I take to mitigate risks and still achieve my goals? KEY TAKEAWAYS It s important to understand the various timely risks to income investing such as rising interest rates and the impact they can have on your portfolio. The key to properly evaluating the impact of these risks is to understand the various income-producing securities you own and why you own them. Work with your financial advisor to assess the role of incomeproducing investments within your overall financial plan and consider strategies available to achieve your goals while managing associated risks.

2 1 u WHAT DO I OWN AND WHY? Individual bonds have long been the traditional option for fixed income, and packaged products such as mutual funds are a popular vehicle to access these investments since they offer money management and diversification. Bonds may also be purchased as part of a separately managed account (SMA), through which portfolio managers select bonds to be owned by the investor directly. In addition to core, high-quality bonds such as Treasuries and corporates, non-traditional fixed income has also gained popularity due to a low-yielding environment. Examples of non-traditional fixed income include: floating rate, high yield, global fixed income and unconstrained strategies. These investments can change your risk profile so it is important to be aware of the unique risks that each strategy contributes to the overall portfolio. Once you identify the bond holdings in your portfolio, it s important to understand why you own them. For example, you may include bonds in your portfolio for: FINRA WARNING TO INVESTORS The Financial Industry Regulatory Authority (FINRA) is a private, nongovernmental agency that regulates its member brokerage firms and the financial markets. Its mission is to protect America s investors by ensuring the securities industry operates fairly and honestly. As part of this effort, FINRA regularly issues explanations on how current market conditions may impact investors. Predictable income Preservation of capital Diversification from equities Total return opportunities Emphasis should be placed on the importance of traditional core fixed income in a balanced portfolio as it is an effective hedge against equity risk. Depending on the specific role these investments play in your portfolio, the associated risk factors will have a different impact on your decision-making process. WAYS TO INVEST IN FIXED INCOME Bonds: Credit rating, coupon rate and maturity date are generally set when purchased, with 100% of money invested and earning interest. Bond funds: Typically pay monthly distributions that vary based on the types of securities the fund manager buys and sells, the amount of cash held in the portfolio, and flows into and out of the fund. Closed-end funds: Payments vary based on bonds and other investments that the fund s manager buys and sells, cash held (though typically fully invested) and current market rates. Closed-end funds that use leverage can increase losses. ETFs: Passive exchange-traded funds provide income similar to the index being tracked by the fund. Since bond funds, closed-end funds and ETFs do not mature and their prices change daily, it is impossible to predict the value of an original investment at the time of sale. 2

3 4 QUESTIONS YOU NEED TO ASK ABOUT INCOME INVESTING 2 u WHAT WILL HAPPEN TO MY PORTFOLIO WHEN RATES RISE? Based on current communications from the Federal Reserve, short-term interest rates are likely to rise in the near future. Although traditionally serving as a lower risk part of a portfolio, bonds do pose risks in a rising interest rate environment. For example, when interest rates rise, bond prices decline. Another issue to consider is that the longer the duration of a bond, the greater its price sensitivity to changes in interest rates. Duration should not be feared, however understanding the benefits, risks, and implications that duration may have in a rising rate environment is prudent. Your financial advisor can assist with the evaluation of your duration risk. SENSITIVITY IN BOND PRICE TO CHANGES IN INTEREST RATES Price/Value ORIGINAL PRICE/VALUE (4% bond purchased to yield 4%) BOND MATURITY (Years from today) ENDING VALUE (After 100 basis point interest rate change) 95.6 (4.4% change) 92.2 (7.8% change) 84.5 (15.5% change) 5 Years 10 Years 30 Years Note these are examples and approximations. This example assumes non-callable bonds. Callable bonds have different sensitivities when they are priced above *A basis point is 1/100 of 1%. A 100 basis point change would be when interest rates move 1 full percent, for example moving from 4% to 5%. The change in value shown is specific to a 100 basis point rate change in similar securities. By extension, if the rate change was 300 basis points, the change in value would be approximately three times what is shown.?how do higher interest rates affect bond duration? Duration is quoted as the percentage change in price for each given percent change in interest rates. For example, the price of a bond with duration of two would be expected to decline by about 2.00% for each 1% increase in rates. If you own individual bonds to receive steady, consistent income, you may not be as concerned about changes in the value of your bonds since they will continue paying out income subject to the creditworthiness of the issuer. However, if you are instead using bonds to achieve an attractive total return, you may want to reposition assets to help you better achieve this goal, since your bond values may drop as interest rates rise. Work with your financial advisor to help you understand the role fixed income investments play in meeting your objectives. 3

4 3 u WHAT OTHER RISKS AM I EXPOSED TO? It is important to understand that there are tradeoffs with every decision you make in your portfolio, as you may find yourself trading one risk for another. For example: Shorter maturity bonds of similar qualities will typically have a lower yield Higher-yielding bonds of similar maturities generally present higher credit risk Non-dollar investments, such as foreign bonds, carry currency and geopolitical risks How certain risks will impact a portfolio differs depending on your objectives and the types of investments you own. The accompanying table details additional risks associated with income investing. ADDITIONAL CONSIDERATIONS There are numerous other risks that you should be aware of when investing in securities designed to provide income. Purchasing power risk: Over time inflation may lower the value of returned principal. This means an investor will be able to purchase less with the proceeds received at maturity. Higher inflationary pressures usually result in higher interest rates. Reinvestment risk: In a rising rate environment, those who lock in an income stream by investing in long-term individual bonds will forgo reinvesting principal upon maturity at higher rates. When rates are falling, those who buy short-term securities or callable securities may face the risk of having to reinvest at lower rates upon maturity. Foreign bonds: Additional risks include, without limitation, liquidity, currency fluctuations, differing accounting standards, political and economic instability, and differing tax laws. Investors may benefit from professional management. High-yield bonds: Not suitable for all investors. The risk of default may increase due to changes in the issuer s credit quality. Price changes may occur due to changes in interest rates and the liquidity of the bond. When appropriate, these bonds should only comprise a modest portion of a portfolio. As with foreign bonds, investors may benefit from professional management. It is recommended that allocations to these strategies be funded from the risk portion of your portfolio. Unconstrained bond funds: Not suitable for all investors. By nature of following no strict investment guidelines, they may expose investors to risks including the use of leverage, market timing risk, geopolitical risk, and volatility. Aggressive pursuance of total return may dilute the benefits of diversification afforded by traditional fixed income strategies as owners of unconstrained bond funds may find themselves more correlated to equity market fluctuations. It is recommended that allocations to these strategies be funded from the risk portion of your portfolio. 4

5 4 QUESTIONS YOU NEED TO ASK ABOUT INCOME INVESTING 4 u WHAT ACTION SHOULD I TAKE? Work with your financial advisor to forecast what if? scenarios and gauge your comfort level with different possible outcomes. Start by confirming why you own income-producing investments, the role they play as a part of your overall asset allocation and evaluate your risk tolerance in view of the risks that may be present going forward. Your advisor can run an analysis on any individual bonds you own to assess their credit quality, exposure by credit rating and diversification across issuers. He or she may be able to use this analysis to quantify the potential impact of rising interest rates on the value and total return of your individual bond holdings. Together, you can determine whether your current holdings are aligned with your investment objectives or if changes may be prudent. While we do not recommend dramatic changes to asset allocations based upon day-to-day market movements, there are a number of strategies available that may help manage long-term risks such as: Managing the duration of your investments appropriately Improving the credit quality of your investments Diversifying across different types of income-producing investments and issuers Reducing bond exposure in favor of alternative asset classes Work with your advisor to forecast what if? scenarios and gauge your comfort level with different possible outcomes. 5

6 REVISIT INCOME GOALS AND STRATEGIES Your financial advisor possesses the tools, resources and expertise to help you make informed decisions. While drastic changes may not be necessary in your portfolio, it s important to discuss these risks with your financial advisor now and take necessary steps to ensure you are well positioned for any scenario. WORK WITH YOUR FINANCIAL ADVISOR Understand the Reaffirm why you Re-evaluate your Forecast potential Identify and products you own bonds and the risk tolerance and scenarios and the implement own and the risk role they play in your understand the risks impact on your appropriate profile associated overall portfolio and currently facing portfolio strategies to with each financial plan income investors manage risks Asset allocation does not guarantee a profit nor protect against loss. A credit rating of a security is not a recommendation to buy, sell or hold securities and may be subject to review, revisions, suspension, reduction or withdrawal at any time by the assigning rating agency. Raymond James financial advisors do not render advice on tax or legal matters. You should discuss any tax or legal matters with the appropriate professional. There are numerous other risks you should be aware of when investing in fixed income. For detailed information on factors to consider when investing in bonds, visit: raymondjames.com/fixed_income_bond_investing_risks Investors should consider the investment objectives, risks, charges and expenses of mutual funds and exchange traded funds carefully before investing. The prospectus contains this and other information and should be read carefully before investing. The prospectus is available from your investment professional. INTERNATIONAL HEADQUARTERS: THE RAYMOND JAMES FINANCIAL CENTER 880 CARILLON PARKWAY // ST. PETERSBURG, FL // // LIFEWELLPLANNED.COM 2015 Raymond James & Associates, Inc., member New York Stock Exchange/SIPC 2015 Raymond James Financial Services, Inc., member FINRA/SIPC Investment products are: not deposits, not FDIC/NCUA insured, not insured by any government agency, not bank guaranteed, subject to risk and may lose value. Raymond James is a registered trademark of Raymond James Financial, Inc. BDMKT TA 07/15