Which is the best option for me: a Savings Portfolio, a Target Portfolio, or a Bond Portfolio? Or even something else?
This is a common question among our clients, especially in recent months.
While the answer ultimately depends on the client, depending on their time horizon and financial goals, we will once again attempt to provide additional information and illustrative examples to aid in decision-making.
Fixed income also fluctuates
The term “fixed income” can be misleading. Although bonds, also known as fixed income, offer a predetermined coupon—unlike equities, whose dividends and appreciation can vary significantly—their value is not fixed until maturity. A bond has an inverse relationship with market interest rates: if interest rates rise, the bond price falls, and vice versa. Bond price volatility is primarily affected by their duration (the longer the duration, the greater the variation) and the associated risk (lower credit quality, higher risk, and vice versa): for example, high-yield and corporate bonds are more volatile than government bonds.
Understanding some of the key concepts that apply to bonds can be complex. If you’d like to delve deeper into these aspects, we recommend reading:
- Inverse relationship between bond price and market interest rates
- Bond duration: Bonds’ relationship to interest rates
- When to increase bond duration
Money market funds are immune to this fluctuation
The inbestMe Savings Portfolio, composed of money market funds, exhibits minimal volatility because it invests in assets with no duration. Therefore, the value of the assets is not affected by interest rate fluctuations, beyond the returns they accrue. However, the rate at which returns accrue can be affected by central bank decisions on official interest rates. As long as interest rates remain positive, the Savings Portfolio will continue to generate returns, albeit at a variable rate depending on these decisions.
The Savings Portfolio is a good option for anyone who wants to create or maintain an emergency fund, save money they may need in the short term (less than a year) or indefinitely, or accumulate money for later use in the short term (months to a year or a year and a half).
In recent years, the Savings Portfolio has generated 1.8 percentage points more than the average one-year deposit (according to the Bank of Spain). However, the Portfolio’s performance has declined in recent months due to the recent ECB interest rate cuts. As a result, some of our clients are considering other options. We review these options below.
Bonds with predetermined maturity: Target Portfolios
When purchasing a bond, there’s always the option of holding it until maturity, while collecting or accruing the coupon periodically.
This can also apply to a target-date fund or ETF containing hundreds of bonds.
The advantage of finding a maturity that fits our objective is that fluctuations in the value of the bond or bonds will be irrelevant. For this reason, we have created Target Portfolios with different maturities.
We observe in the following historical performance charts that the Target Portfolios accumulate slightly higher returns than the Savings Portfolio, and that their returns increase with maturity. However, they also exhibit greater daily variability due to market dynamics.
And that fluctuation is more evident depending on the duration and as we focus on the time period analyzed.
However, investors who choose a target portfolio should ignore these fluctuations. This is because, on the target date, they can be highly certain of achieving the cumulative target return. It’s similar to buying a bond: if we wait until maturity, we get the principal plus interest (unless the issuer goes bankrupt). In this sense, this risk is negligible in target portfolios, as they are composed of hundreds of highly rated bonds.
Therefore, it is advisable for an investor to choose a Target Portfolio if:
- Your investment goal/horizon is longer than 1 or 1.5 years.
- Your goal/horizon matches one of the ones we suggest.
- You’re confident you won’t need the money before the target date; otherwise, a Savings Portfolio is better due to its flexibility and near-zero volatility.
- You understand that although there may be variations during the maturity period of the target portfolio, these don’t affect you because your goal is set on the target date.
We’ll provide more details later, with some practical examples of when to choose one or the other, and other useful information:
- Savings Portfolios vs. Target Portfolios: Examples to Help You Make the Best Decision
- We launched 2028 Target Portfolios with cumulative target returns of up to 18.5%
Bonds with no maturity date and different durations: Bond Portfolios
At inbestMe, we’re expanding our offering with bond portfolios of two different durations, in response to the new situation (rising interest rates). These portfolios are: the Conservative Bond Portfolio, with a short duration, and the Aggressive Bond Portfolio, with a longer duration.
As we’ve said, duration generally implies greater volatility, that is, greater variation in the value of bonds when interest rates fluctuate. This can be seen in the charts we share in this section.
The longer the duration, typically, the higher the bond’s yield, unless the yield curve is inverted, which will also be reflected in yields over time. But again, as we zoom in on the most obvious periods, potential temporary declines become apparent.
Viewed over very short periods of time and depending on the time of entry, we can see more visible temporary drops in a Bond Portfolio as opposed to a Savings Portfolio, and again, this is more visible the longer the duration (more evident in the Aggressive Bond Portfolio than in the Convervative Bond Portfolio).
Therefore, a Bond Portfolio can be a good option for investors who:
- They want to avoid the high potential volatility of equities.
- They accept some short-term volatility to benefit from potentially higher returns than the Savings Portfolio or the Target Portfolios.
- They have a somewhat undefined investment objective, but one of more than two years for the Conservative Bond Portfolio and more than three years for the Aggressive Bond Portfolio.
For longer-term goals, consider diversified portfolios (bonds, stocks, and others).
For medium to long-term goals, or those related to retirement or capital accumulation, diversified portfolios that include bonds and stocks are more appropriate, as equities historically offer superior long-term returns, allowing them to outperform inflation more significantly. However, it’s important to keep in mind that this type of portfolio entails greater volatility and, therefore, greater risk. In other words, the more equities we hold, the more subject we are to what is known as the “risk premium.”
The chart above shows that higher cumulative returns correlate with higher risk profiles. However, this also means that temporary losses are much more significant. In the period represented, these losses reached -6% (being higher depending on the risk profile). It is important to note that during periods of extreme market declines, these losses could be even greater (declines such as Covid or inflation/Ukraine are not visible in this chart because they occurred in previous periods).
A portfolio for every financial horizon, objective or profile
We understand that many of our clients are guided by the IRRs, or expected returns, of our portfolios. Being guided solely by returns can be a mistake.
In this post, we attempt to show that, in conclusion, the best portfolio choice depends on each client’s individual circumstances. Although we have provided information and analysis to assist in decision-making, it is ultimately up to the client following our recommendation to determine what is best for their needs.
To assist in this process, during registration and profiling, we use a questionnaire that takes into account your investment horizon, financial goal, and other factors to recommend the most appropriate portfolio.
We also remember that, given the uncertainty of investment horizons, it can be beneficial to have multiple portfolios, each with specific potential objectives.
This is a feature available in inbestMe, and goal-based investing is part of the inbestMe approach.
This can help us better manage logical uncertainties about our goals and better navigate market volatility.
You can read more at:
