An important distinction must be made between income and cash flow. Income is what your investment earns. If you put $10,000 into an investment and accumulate $11,250 over a 5 year period, you earned $1,250 ($250 per year or a 2.50% yield).
This math does not change when you pay a discount, par or premium for a bond. Income accumulated is the difference between what you put in and what you pull out of a security over any period of time.
When interest rates are low (like now), some investors require more cash flow than income can provide. Cash flow is coupon times the face value of the security. On a par ($100 price) bond, income and cash flow are the same. On a premium bond, cash flow represents income plus return of principal. A premium bond’s cash flow includes income plus return of principal; therefore, cash flow is greater than on a par bond.
A higher cash flow does not necessarily mean you are earning more income, it just accelerates the pace principal is returned. That means more cash flow to meet your needs. Those needs could include reinvesting more of your money sooner rather than waiting for it to mature or it could be providing sufficient cash to pay the rent. In the case of a premium bond, if you spend all of your cash flow, you are spending all of the income plus a portion of your principal.
You are using your principal, not losing it. IRA accounts are often strategically constructed to provide for your retirement needs. Using part of your lifelong savings to do this can be part of your strategic portfolio plan. For investors with higher cash flow needs than the market currently provides in income, high coupon bonds can deliver that cash flow, regardless of interest rates.
Executing higher cash flow plans can be done in many ways. Corporate traders’ insight reveals investment grade corporate bonds in the telecom and industrial sectors around 2028-2035 have been providing opportunities for greater cash flow in higher coupon bonds. Longer holding periods allow for continued cash flows.
Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, Certified Financial Planner™ and federally registered CFP in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.
Securities offered through Raymond James Financial Services, Inc., member FINRA/SIPC. Investment advisory services offered through Raymond James Financial Services Advisors, Inc. Kendrick Wealth Management is not a registered broker/dealer and is independent of Raymond James Financial Services.
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