Jerry M. from Casper, WY asks: Good evening, Mitch. If interest rates are going to keep going up, which seems to be unavoidable, does that mean now is a bad time to own bonds? If I already own bonds, is it too late to make changes?
Mitch’s Response:
Thanks for writing, Jerry. For readers who may not understand the reasoning behind your question, you are referring to the inverse relationship between interest rates and bond prices. When interest rates go up, bond prices go down, which is why you’re questioning the ownership of bonds in a rising rate environment.
But rising rates alone are not necessarily a good thesis for avoiding or selling bonds. Over time, the performance of bonds and stocks are not tightly correlated, which means many investors can derive benefits from owning bonds as a diversification tool. Bonds can help mitigate equity risk and volatility over time.1
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In my view, ownership of bonds in your investment portfolio is more about what your long-term goals and objectives are, not necessarily a factor of whether interest rates are poised to go up or down. If, for instance, you are already well into retirement, want to minimize volatility, but still need some growth and income, it’s likely that bonds would make sense as part of your overall asset allocation. During a recession and bear market, for example, bonds are likely to help mitigate some of the downside experienced on the equity side of the portfolio.
That all being said, investors should certainly try to actively manage bond portfolios through various interest rates and market cycles. Using bond ladders is an example of an approach that allows an investor to use proceeds of a maturing bond to invest in new bonds, such that the duration of the bond portfolio remains steady but new bonds with different – and perhaps higher – yields are periodically introduced into the portfolio. Higher yields of newer bonds can make up for price dips along the way.
Another factor to keep in mind is that credit quality in the U.S. is very strong, in terms of U.S. Treasury bonds, investment-grade corporate bonds, and municipals. In other words, these bonds are almost certain to make their interest payments on time over the life of the bond, as well as reliably return principal once the bond matures. There’s still plenty of safety to be found for investors willing to hold bonds to maturity, which underscores a key reason for owning bonds in the first place.
I think the bottom line here, Jerry, is to think about what purpose bonds are serving in your portfolio, and how they fit into your longer-term goals and objectives. In other words, I would focus less on interest rate forecasts and more on what you need within your own financial and retirement planning.
Even in times like these when interest rates are rising, do you know that investors still have an advantage over market volatility? There are positive aspects of it that you don’t want to overlook. You have the opportunity to make the most out of these challenging times!
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Disclosure