Atlantic Capital Management

Atlantic Capital Management (79)

Wednesday, 08 March 2017 21:07

Worried About What Might Happen to Bonds?

Written by

If you plan to hold yours to maturity, the fluctuation in their market values need not be worrisome.

Are tough times ahead for the bond market? Some investors think so. U.S. monetary policy is tightening, with the Federal Reserve planning gradual increases for the key interest rate.

A rising interest rate environment presents a challenge to the bond market, but it does not necessarily imply some kind of doomsday for bondholders. Blanket advice to “get out of bonds” is imprudent, because it really all depends on what you intend to do with the debt investments you hold and how long you intend to hold them.

Rising interest rates affect the market values of bonds. Repeat: the market values. Market values should not be confused with face values.

To illustrate, say you invest $5,000 in a 30-year Treasury with a 1% yield. That means that every year for the next 30 years, that Treasury note will pay out $50 to you.

Then, interest rates on 30-year notes start climbing. Three years later, they reach 2%, and you have a problem if you want to sell your 30-year Treasury. The problem is that no one will buy it for $5,000. Why pay $5,000 for a 30-year Treasury with a 1% yield when you can invest the same $5,000 in a brand new one set up to yield 2%?

Bond yields and bond prices move in opposite directions, and in order for your $5,000 30-year note to yield 2%, its price (read: market value) has to drop to $2,500. The market value of your bond has fallen below its face value, and if you sell it, you will take a loss.1

Rising interest rates do not affect the face values of bonds. So, if you hold onto that 30-year Treasury until its maturity date, you will get your $5,000 principal back at that point, plus $50 per year in interest along the way.

There is a potential downside to holding onto that bond, however, and it may be measured in opportunity cost. Yes, you are avoiding a loss and redeeming your security for its face value. The thing is, you could, potentially, have put your money into another investment with a better yield – a yield that could have kept up with or surpassed the rate of inflation.

This is why some investors favor a laddered bond strategy. They take the interest their bonds pay out and use that money (and other funds) to buy newly issued bonds at higher interest rates, so they can benefit from the upside of a rising interest rate climate. Lower-yielding bonds in their portfolio are gradually replaced by higher-yielding bonds over time. Through this strategy, they can plan to manage interest rate risk and cash flow.

When interest rates fall, the market value of older, higher-yielding bonds rises. Interest rates do not have very far to fall right now, but this is a detail to remember for the future.

A fear of higher interest rates does not necessarily imperil bonds or bond funds. As a recent example, one bond market benchmark – the Vanguard Long-Term Treasury Fund – rose 13% in the 12 months ending in November 2016.2

In the long run, we may see interest rates normalize. Bond investors planning to reinvest their money in newly issued bonds with higher yields can potentially take advantage of such a development.

Regardless of whether interest rates rise, plateau, or fall, remember that their movement does not affect a bond’s total return over its term.

 

This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note - investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

Citations.
1 - thebalance.com/the-difference-between-coupon-and-yield-to-maturity-417080 [6/3/16]
2 - forbes.com/sites/robertberger/2016/11/30/how-rising-interest-rates-affect-bonds/ [11/30/16]

Thursday, 16 February 2017 16:01

The Cross-Purchase Buy-Sell Agreement

Written by

A plan for sustaining the business you have built after your death.

Business owners are builders. They spend their lives building firms to provide goods and services to their clients, and those firms provide them with a living. But nothing can tear down that lifetime of work faster than the death of a business owner, or the death of a business partner. Often, much of the value of a business dies with the owner.

Small business owners face two major succession questions. First, can the business heirs keep the company afloat when the owner dies, or at least avoid surrendering it at a “fire sale” price?

The executor of a deceased business owner’s estate can elect to continue the company, but must find someone willing to run it. That may not be easy. Some heirs or business partners may want to keep things going; others may want to cash out. This discord can potentially sink a firm, because if the business continues, any partners wanting out will want to be fairly compensated. If sufficient cash isn’t on hand to do that, liquidation may be the only option.

Selling the business means finding a buyer. Any potential buyer will be negotiating with an advantage, for the business will become less valuable with each passing day following the owner’s death.

Now to the second major succession question: how can an owner keep employees confident that the business, and their jobs, will continue after he or she is gone?

Surviving business partners may need to be reassured as well. If one partner dies, the remaining partners may find themselves in business with the deceased partner's heirs, who may have different goals for the company. If the heirs want to sell their inherited ownership interest, is there enough cash on hand to buy it?

These questions can throw the value & continuation of a business into doubt. If left unanswered, they could make creditors more likely to call in loans, and make retaining key employees harder.

Cross-purchase buy-sell agreements are designed to answer these questions. Often funded by life insurance, these agreements are essentially deals struck between owners, partners, or key employees of a business, permitting the sale of their ownership share to another person.1

How do they work? In the classic cross-purchase buyout agreement, each business partner takes out a life insurance policy on the other partners within the company, naming himself or herself as the beneficiary of those policies. If one partner passes away, then one or more beneficiaries can use the life insurance proceeds to buy the deceased partner’s ownership interest. This way, partners or key persons can continue to work and operate the business seamlessly, and the deceased partner’s heirs receive a fair, agreed-upon price for the ownership interest.1

Thanks to the buy-sell agreement, both heirs and partners know that the business is positioned to continue. In addition, greater productivity and loyalty may be seen from any key employees made part of the agreement, who see ownership in their future.

The sale can happen rather quickly; estate issues can be settled more expediently. Heirs will get a fair, pre-determined price for the ownership interest, and won't be selling under duress.

These agreements do have some disadvantages. Participants have to trust and verify that each partner keeps his or her insurance policy in force. This isn't as simple as making sure premiums are paid. Usually the policies are owned personally, not by the firm. If a partner suffers a bankruptcy, federal or state exemptions may not protect all of its cash value from creditors. Sometimes a participant will mistakenly buy an insurance policy on her or his own life and make the other participants beneficiaries; under those conditions, the insurance payout resulting from his or her death will likely be taxed.2,3

As the number of partners involved in a buy-sell agreement increases, the number of policies grows exponentially – as does the cost of the agreement. Two partners? Two policies. Three partners? Six policies. (When three partners are involved in a cross-purchase buyout agreement, Partner A needs to buy coverage for Partner B and Partner C, etc.) Speaking of cost, an older or less healthy partner will pay much more for the agreement than a younger, healthier partner, as life insurance is a necessary component.2,3

Before you make a decision about how you’ll protect the future of your business, it may be wise to speak to a qualified professional who can help you research this option as well as others.

  

This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note - investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

    

Citations.

1 - nerdwallet.com/blog/insurance/life-insurance-small-business-partners/ [1/20/16]

2 - insure.com/life-insurance/bankruptcy.html [11/13/15]

3 - insurancenewsnet.com/innarticle/how-to-keep-a-buy-sell-agreement-from-derailing [5/21/15]

Our Blog

2017

(10 articles)

2016

(24 articles)

2015

(15 articles)

2014

(18 articles)

2013

(12 articles)

2012

(3 articles)