The Tricky Dance with Bonds
- Unlike stocks, many investors have trouble understanding the bonds in their portfolios.
- Bond values go down when interest rates rise—something we’re likely to see later this year when the Fed inevitably raises rates.
- You don’t want to get caught holding long-term bonds if you have to sell them in a rising rate environment.
*** If you have questions about your bond portfolio, contact us for a complimentary Second Opinion at 800-480-7913 or email@example.com.
Do you remember “bearer bonds” from 30 to 50 years ago? Those bonds had actual physical coupons that you could clip and redeem at your bank for cash. Bond coupons were similar to grocery coupons then, and made it easy for people to understand how bonds worked.
Of course, everything’s electronic today. Interest rates and bond values change constantly. While most folks understand stocks fairly well, they tend to get confused by bonds because there’s more math involved and because bond values move in the opposite direction from interest rates.
Interest rates are historically low right now. We know that the Fed is likely to raise rates very soon (finally), and that means bond values will go down. When that happens, you will get less for your bond than if you hold it to maturity.
If you buy a 5-year Treasury bond right now, it’s paying about 1.5 percent interest. If interest rates on that bond go to 3 percent from 1.5 percent today, and if you go to sell that bond before it matures, then you would lose about 7 percent on your investment.
It gets worse on the longer end of the spectrum. Suppose you own a 30-year bond at 3 percent. If that rate goes to 5 percent (the historical average), you would end up losing 30 percent. For example, if you bought the bond at $100,000, its value would go down to $70,000 if you didn’t hold it for 30 years at 3 percent. You don’t want to be caught having to sell long bonds in a rising interest rate environment.
What’s your alternative?
There are alternatives, each with pluses and minuses. You can stay on the “short side”—five years or less. In this case, you get really low rates (0.5% to 1.5%), but, as mentioned above, they will lose less than a long bond when interest rates rise. Or, you can invest in bonds which are influenced by more than just interest rate changes, such as foreign bonds, high-yield bonds and mortgage bonds.
You can also buy dividend-yielding stocks to get a steady stream of income. Just remember that stocks are more volatile than bonds, especially in bad markets.
The key thing to remember here is: when interest rates move up, bond values go down. Holding 30-, 20- or even 10-year Treasury bonds can have a real negative effect on your portfolio.
If you have bonds in your portfolio and aren’t sure what to do with them in a rising interest rate environment, then give us a call (800 480-7913). We have a complimentary Second Opinion service, so you can come in and talk to us. We’ll walk through your holdings, point you in the right direction and hopefully make life a little simpler for you.
Until next time, enjoy.
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