“Interest rates destined to spike, bonds will be crushed!”
OK … we’re not sure if anyone has actually said those exact words, but based on market headlines over the past few years, it’s certainly been a recurring theme. Shoot, we might even have said something similar a time or two! And despite the fact that it hasn’t happened yet — and might not — this isn’t alarmist thinking. Here’s why.
One of the ways the Federal Reserve has successfully kept interest rates near historic lows is by purchasing enormous quantities of bonds. Remember, interest rates and bond prices are inversely related. So, those low rates have helped prop up bond prices. You may have heard about this strategy in the news. It’s called “quantitative easing.”
The concern this creates for many of us is that the Fed can’t keep buying bonds at this pace forever. Eventually, they have to slow down or stop and, eventually, the tide will turn for the bond market though these things might not happen at the same time. And when the tide does turn, bond investors are likely to feel some pain.
So as the title of this piece asks, what should you do with your bonds?
For starters, you should keep your eye on the markets and the headlines, but not to the point that it causes you to make a rash decision. Is it prudent to make some changes to your portfolio in light of possible market movements? Absolutely. But “some changes” probably does not equate to “radical changes.”
None of us — not the guy you saw on TV yesterday, not the woman who wrote the article you recently read, nobody — knows for sure what any particular segment of the investing world will do or exactly when it will happen. For example, it was just a few years ago that there was all sorts of public speculation about the possibility of the municipal bond market collapsing under the weight of a huge numbers of defaults. Guess what? Didn’t happen. Since we can’t know for sure what's going to happen, it’s usually prudent to build a plan, stick with the plan and then make minor adjustments and updates along the way.
Make Calculated Adjustments
In our work at USAA, we’re blessed to have access to the thinking of the really smart men and women who manage our investment portfolios and those of our members. (For real, it sometimes hurts our follically challenged heads when we talk to them.) Here’s what they think about this topic:
- Long-term interest rates in the U.S. should gradually rise over the next two to three years.
- The timing of this is difficult to predict so you should remain diversified.
- If you’re over-allocated to bonds, you should consider making a modest shift from fixed income to equities, where suitable and appropriate.
- Portfolios with substantial allocations to high-grade bonds might benefit by partially shifting some of these holdings to higher-yielding bonds as possible insulation against rising interest rates.
- Shorter-duration, interest-sensitive bonds will generally be less affected by rising rates than longer-duration holdings. So where suitable and appropriate, it may be prudent to decrease the average duration of bond portfolios.
Some thoughts on suitability
You don’t have to scrutinize these thoughts too closely to see a recurring theme of suitability and appropriateness. This is intentional. Since we have no way to know your individual situation, we can’t just make a blanket statement that these points are something you should implement. Any changes you make should support achievement of your own goals and be in line with your risk tolerance and time horizon. We don’t want you losing sleep or taking next year’s vacation money and plopping it into something that’s could lose value! Again, the adjustments have to fit your needs.
As a couple of guys who started our careers as financial planners more than 20 years ago, do you know what we love about our team’s guidance? It’s not some fire-and-brimstone proclamation about things to come. Nor is it an arrogant assertion issued with unwarranted certainty.
Instead, in our minds, it’s thoughtful, educated guidance designed to help investors adjust to the current realities of the market and the economy. Is it guaranteed to be right? Of course not. Even with all of their education, tools, resources and experience, our team isn’t right about these things 100% of the time. Nobody’s team is. But we’ll take thoughtful and calculated over apocalyptic and alarmist any day.
- This material is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing.
- Investing in securities products involves risk, including possible loss of principal.
- Past performance is no guarantee of future results.
- As interest rates rise, existing bond prices fall.
- Some income may be subject to state or local taxes or the federal alternative minimum tax.
You must be a registered user to add a comment here. If you've already registered, please log in. If you haven't registered yet, please register and log in.