The recent spike in market volatility has left many investors concerned about their portfolios and uncertain as to how a rise in interest rates impacts their bond investments.
LET’S START WITH BONDS 101, HOW DO BONDS WORK AND WHY DO WE BUY THEM?
- Bonds are generally conservative investments and they produce income – their interest rate or “yield.”
- Corporations and governments borrow money to operate.
- They pay interest to us until they pay us back (the bond’s maturity date).
WHY IS IT IMPORTANT TO PAY ATTENTION TO INTEREST RATES?
- An existing bond’s price will fluctuate in reaction to interest rates in our economy.
- Is my bond’s rate higher or lower than what a new bond provides?
- My bond’s price will go up or down to compete with new bonds.
WHAT IS BEHIND THE RECENT BIG JUMP IN BOND RATES?
- Inflation expectations are up. The Federal Reserve may raise key interest rates to tap the brakes on our economy.
- Prospect of higher budget deficits. The government may need to pay higher interest rates on new bonds to attract investors.
WHAT DOES THIS MEAN FOR INVESTORS WHO WANT SOME BONDS IN THEIR PORTFOLIOS?
At this stage:
- Still a good stable asset.
- Emphasize Shorter maturities; and,
- Higher credit quality bonds (A-rated vs. junk bonds).
- With individual bonds, you might ladder bonds over one to five years.
- For most investors, consider investing in professionally-managed bond mutual funds.