Do not forget investing in bonds when interest rates go up
Investors know that when the interest rates start to climb, it means bonds will take a hit. This causes many investors to wonder exactly what they should do. Is it a good idea for investors to get out of bonds entirely? Should they invest in bonds that have short maturities or long? Should they choose bond funds or individual bonds?
What Will Happen in the Bond Market?
One of the first things to realize is that bonds can be unpredictable and no one knows exactly what they will do when the policies change. It’s true that the interest rates will rise from their current levels and bonds and bond funds will lose value. Most experts believe that when the interest rates rise, the short-term bonds will be harder hit than long-term bonds.
Some believe that the rising rates will not only hurt the bond market, but that it could actually create a doomsday scenario for bonds. However, it is not a certainty. The interest rate movements can be affected by a number of things, and it does not necessarily mean that the bonds will fail entirely. Still, investors need to be aware of the possibility so they can make the right decisions with their investments.
What Should Individual Investors Do?
Should a new investor, such as a millennial, invest in bonds as part of their long-term strategy? Investors are typically looking for their investments to provide three things – income, ballast, and predictable returns.
Most bonds will not provide a good income. However, when using long-term bonds or sub-investment grade bonds, they could provide a greater yield – between 5% and 6% in most cases. Of course, this does involve taking on more risk.
Bonds in the past have been capable of providing some protection for investors. The lower yields of today though will not provide as much protection as most investors would like. However, they can help investors to keep their assets stable, even when stock prices start to decline. One of the concerns over investing in bonds today is that they could be dealt a 50% or greater decline in value when the interest rates go up.
Because of the dangers, it is far more advisable to invest in short to intermediate term individual bonds. This has the potential to work quite well for long-term investors who want to build up their nest egg. While some bonds, such as high yield bonds, are more volatile and cannot provide the same diversification as individual bonds, they could still be useful for those investors who plan to hold onto the bonds until their maturity. At that point, volatility is not as much of a concern. When the interest rates rise, it typically means the economy is improving, which means that the high yield bonds could actually rise in price. This can balance the investment into investment grade bonds and treasuries.
You can move your fixed income portfolio from bond funds to individual bonds and then diversify. The manner in which you choose to invest in the bonds will be determined by your risk tolerance.