Here’s how rising interest rates may affect your bond portfolio
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Retirees often rely on bonds to provide their income, reduce risk and grow their portfolios. The Federal Reserve has a different opinion. prepares to raise interest ratesSome are concerned about what the consequences could be for their nest eggs.
With the Consumer Price Index (the key indicator of inflation), the cost of living has increased for several months. rising 7% year over year in DecemberAccording to the U.S. Department of Labor, this is the most recent record since 1982.
Federal Reserve Chairman last week Jerome PowellHe stated: expects a series of rate hikesWith reduced central bank pandemic support, this year will see a decrease in inflation.
Investors may be alarmed by this because bond prices and market interest rates tend to move in opposing directions. This is known as interest rate risk. Higher rates can cause bond values fall.
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Imagine that you own a 1,000-year bond, with a 3% coupon. The asset may lose value if the market interest rate rises to 4% within a year.
Price drops are due to new bonds being issued with higher coupons of 4%. This makes the original 3% bond less desirable unless it can be bought at a lower price.
Higher yields in other countries lead investors to sell current bonds and purchase higher-paying securities. Prices slide when there is heavy selling, said Brad Lineberger, certified financial planner, of Carlsbad’s Seaside Wealth Management.
How bond duration is important
The duration concept is another fundamental aspect of bond investing. It measures a bond’s response to changes in interest rates. This is expressed in years and it differs from bond maturity. It factors in coupon, maturity time, yield, and term length.
Lineberger explained that the shorter a bond lasts, the more it is sensitive to increases in interest rates and its value will drop.
You should generally consider shorter-term bonds and bond funds if your goal is to decrease interest rate risk. Paul Winter, CFP and co-owner of Five Seasons Financial Planning Salt Lake City, stated that this was the best way to do so.
He said that bonds with lower coupon rates and credit quality are less likely to respond to higher interest rates than other factors.
A longer timeline
Although rising interest rates can cause bond prices to drop, they will eventually be compensated by the maturing of bonds and the possibility for higher yields. This is according CFP Anthony Watson who founded and heads Thrive Retirement Specialists Dearborn.
He said that rising interest rates were good for those who have a longer time frame to retire, which is most of the people living in retirement.
Watson says that diversifying your portfolio includes international bonds and short-term maturities to help you manage risk. This is a great way to lower interest rates.
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