Rising Interest Rates and Bonds…What Should You Know?
In June, Ben Bernanke’s talk on tapering bond purchases caused a record outflow from bond funds in the month of June. In July, bond funds continued to see a net outflow after general trend of net inflows for several years. With Bernanke’s comment, we also saw mortgage rates jump almost a full point in June. Why is this important to you as an investor? If you invest in bonds, it is critical to monitor the factors that impact your expected return. One of the first things we learn in the financial advisory business is the relationship between interest rates, bond prices and bond yields. There is an inverse relationship between bond prices and interest rates. If interest rates drop, bond prices appreciate. Many bond investors have benefited from declining interest rates over the last several years. As interest rates have dropped, bond prices have appreciated. At the same time, bond yields have dropped. Since we have been in a historically low interest rate environment, most feel rates will rise over the next several years. What does this mean for bond investors? This means that bond prices could drop and bond yields could rise. If your bond prices drop it affects the overall return of your portfolio. The bonds still provide a coupon payment (interest payment), but the associated return from the coupon payment is reduced by a decline in the bond price. If you are a bond investor, this could mean you might see lower than average returns on your bond funds and possibly even a negative return on your funds as interest rates rise. What should you do about it? There are a number of strategies to help minimize the impact of rising rates on your bond portfolio. The strategy that is right for you depends on your goals and risk tolerance. If you invest in bonds or bond funds, we strongly encourage you to measure the impact rising rates might have on your portfolio and we are happy to provide a second opinion on the action you may take to realign your portfolio.