Bonds–The Tide Has Turned and the Sky Darkened
But you can thrive, not just survive, in the rising interest rate storm if you think strategically about your fixed instruments.
- Most investors need reliable fixed income sources to protect against a downturn in the stock market.
- But, with the Fed tapering its bond-buying stimulus program, most expect interest rates to rise. That’s not great if you hold long-term Treasuries or corporate bonds.
- When interest rates move up, you have a bear market in bonds, something we haven’t experienced in over 30 years–and it may be hard to adapt our thinking.
- As a strategic investor, seek alternatives to long-maturity U.S. Treasuries and AAA-rated corporate bonds that aren’t as vulnerable to rising interest rates.
As many of you know, the Federal Reserve Board recently agreed to taper its bond-buying economic stimulus program. It’s something we’ve been expecting—some would say dreading–for a long time. It means the Fed thinks the economy’s recovered to the point that it can move forward on its own. That’s great for business and job seekers, but what does it mean for you and I as investors? Rising interest rates.
When interest rates rise, you have a bear market in bonds, which isn’t something we’ve experienced in over 30 years. But it’s a huge issue now because it’s really going to change direction. For instance, a 1-percent interest rate rise means that if you owned a 30-year Treasury bond, its value goes down by 19 percent. And if you owned a 10-year treasury, its value goes down by about 9 percent. If interest rates rise while you’re holding those long-term Treasuries to maturity, you’re potentially missing out on thousands of dollars a year in fixed income if you hold a $100,000 bond portfolio.
Strategic alternatives to Treasuries and AAA bonds
Obviously you want to avoid this. So, we’re talking about really changing the portfolios that we hold relative to the fixed-income part—not the stock market part, which is even more volatile than the bond market. For instance, there are other areas to invest in for fixed income such as floating rate instruments, mortgage-backed securities, high-yield bonds, and debt from emerging and international markets.
Why consider these? They have shorter maturities than long treasuries or AAA-rated corporate bonds and thus aren’t as vulnerable to rising interest rates in the short-term. And you want part of your portfolio to be in these “debt instruments” to protect yourself from a big stock market downturn. So, this transition is happening right now and you want to review your portfolio to see if you’re positioned strategically to take advantage of what is coming down the line.
If you are holding interest-rate sensitive instruments, you’ll want to talk to your counsel about making the changes we’ve discussed. If you don’t have counsel to advise you on fixed income, give us a call. We’re happy to help.
So until next time, enjoy. Gary
For additional reading on bear market bonds, check out this NY Times article by Bill Gross.
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