Worried About Bonds?

In recent weeks, there has been increasing chatter over rising interest rates and the risks they may pose to bond investors, financial markets, housing and the economy in general. The media has been fanning the flames for the most part, stoking anxiety among some investors. After all, bad news sells.

The underlying concerns are valid. Although still a mixed bag, the economy does seem to be gaining at least some traction and that should be reflected in higher interest rates. Recent comments from Federal Reserve Chairman Ben Bernanke reminded financial markets that the Fed’s bond-market-friendly policies will eventually be unwound. But the nervous hand wringing is overdone, in our opinion.

We have a simple message for our clients: Relax. Take a deep breath and know that, for a variety of reasons, higher interest rates do not spell the end of the world. For example:

  • Interest rates reached record lows in 2012, and their recent rise has been an orderly one for the most part. What we are seeing is a process of normalization, not disaster.
  • There is a certain yin and yang to investing. Periods of upheaval can be challenging, but they can also create opportunity for patient and savvy investors. We believe that’s the message from recent bond-market behavior.
  • Because their historic return patterns are not closely correlated to other major asset classes such as stocks, investment-grade bonds can play an important role in a broadly diversified portfolio. Fear-driven or panic-induced selling undermines those beneficial effects. To succeed, a long-term investment strategy requires patience and discipline through different types of market environments.

Perhaps most importantly, the mechanics of bond investing lend strong support to the case for remaining calm. At its most basic, a bond investment involves purchasing a series of future cash flows (periodic interest payments plus repayment of principal on the bond’s maturity date). As long as an issuer does not default on those payments, and as long as an investor holds a bond to maturity, the bond will provide those expected cash flows, independent of changes in its market price.

For fixed-income investors, there is also an obvious silver lining to a rising-interest-rate environment—it means new investments and cash flows from current holdings can be put to work at higher yields. All else equal, bond investors should welcome a more normal interest-rate environment.

Of course, today’s fixed-income markets are far from plain vanilla, and for many investors, it makes sense to at least consider professional fixed-income management. Skilled active investment managers have the expertise and resources to identify the various kinds of opportunities created by recent volatility. Through our investment process, we partner with firms like SEI to evaluate, hire, and oversee managers that it believes are best qualified and positioned to help investors pursue their investment objectives.  It is certainly a good time to have a professional advisory team helping to navigate the ever changing market place.

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