Investors in
longer-term Treasuries could really be punished.
Provided by Benjamin Bogetto
Are bond investors facing the possibility of major losses?
Recently, bond yields have climbed. From November 1-23, the 2-year Treasury
yield went from 0.83% to 1.12%, while the yield on the 10-year note rose from
1.83% to 2.36%.1
Quality bonds
have a place in a portfolio, but many investors are moving their money
elsewhere. They see a federal stimulus ahead in 2017, one that could
potentially strengthen the economy and lead the Federal Reserve to gradually
tighten interest rates. Assuming that happens and appetite for risk remains strong, what will
happen to bonds and bond funds when rates begin to climb?1,2,3
The impact of rising rates will vary.
Bonds and bond funds are different animals; some might even call them different
asset classes.
In a rising-interest-rate
environment, bond fund investors commonly see principal values decline until
rates level off or dip again. The more intermediate-term and long-term bonds a
fund holds, the bigger the hit it may take. A diversified bond fund will
reinvest interest payments into new bonds with higher coupons, however –
meaning investors will see larger returns with time.2,3
Long-term bonds
tend to be hit harder by higher rates. They may lose market value, but eventually the
higher rates will result in extra income for the patient investor.2,3,4
How about short-term and intermediate-term
bonds? Some analysts warn against
purchasing short-duration Treasuries and municipal and corporate bonds,
contending that these debt securities might be hurt the most should the pace of
rate hikes quicken. Others disagree.2,3,4
Higher rates have not always imperiled the bond market.
Before December 2015 (when the Fed decided to raise rates again), the economy
had seen six
rising interest rate environments in 40 years. Those periods lasted from two to
five years, with T-bill rates rising between 2.3-11.9%. In those six instances, the total annual return for the Barclays
U.S. Aggregate Bond Index (the S&P 500 of the bond market) ranged from
2.6-11.9%, with most of the total annual returns at between 4-6%. In short, no
disaster for a bond investor.2,4
Still, if the
federal funds rate rises 3% over a period of a few years, a longer-term
Treasury might lose as much as a third of its market value as a consequence –
and if bulls happen to run on Wall Street with only brief retreats between now
and 2025, how attractive will a short-term or intermediate-term Treasury be?
What if you want or need to stay in bonds? Some
bond market analysts see merit in exploiting short-term bonds with laddered
maturity dates. The trade-off: accepting lower interest rates in exchange for a
potentially smaller drop in the market value of these securities if rates rise.
If you are after higher rates of return from short-duration bonds, you may have
to look to bonds that are investment-grade, but without AAA or AA ratings.2,3,4
If interest rates begin heading north
soon, exploiting short maturities could position you to get your principal back
in the short term. That could give you cash, which you could reinvest as
interest rates presumably go up further. If you primarily see pain ahead for
bond owners, you could consider limiting yourself to small positions in government bonds,
investment-grade corporate bonds, and bond funds with durations of 10 years or
less.2,3,4
Bonds still belong in the big picture.
In a bull market, putting money into an investment returning 1.5% for 10 years
may seem nonsensical. It may make more sense in light of the goal of portfolio
diversification and the need for consistent returns.3,4
If interest
rates rise continually during the next few years, current owners of long-term
bonds might find themselves losing out in terms of their portfolio’s potential.
On the other hand, bonds have never lost half their value; stocks have.
This material was prepared by MarketingPro, Inc., and does not
necessarily represent the views of the presenting party, nor their affiliates. This
information has been derived from sources believed to be accurate. Please note
- investing involves risk, and past performance is no guarantee of future
results. The publisher is not engaged in rendering legal, accounting or other
professional services. If assistance is needed, the reader is advised to engage
the services of a competent professional. This information should not be
construed as investment, tax or legal advice and may not be relied on for the
purpose of avoiding any Federal tax penalty. This is neither a solicitation nor
recommendation to purchase or sell any investment or insurance product or
service, and should not be relied upon as such. All indices are unmanaged and
are not illustrative of any particular investment.
Securities offered through First Heartland Capital, Inc. Member FINRA/SIPC
Bogetto Financial is not affiliated with First Heartland Capital, Inc.
Bogetto & Associates does not provide legal or tax advice. These topics are discussed in conjunction with your CPA, Tax Advisor and Attorney.
Citations.
1 - treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield [11/23/16]
2 - thestreet.com/story/13393037/1/how-to-invest-in-bonds-as-interest-rates-start-rising.html [12/20/15]
3 - money.cnn.com/2015/04/29/retirement/bonds-investing/ [4/29/15]
4 - marketwatch.com/story/how-your-bond-portfolio-can-survive-higher-rates-2015-04-23 [4/23/15]
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Website - www.bogettoandassociates.com
Telephone - 314-858-1602
Email - peter@bogettoandassociates.com
10805 Sunset Office Drive, Ste. 202
St Louis, MO 63127
Website - www.bogettoandassociates.com
Telephone - 314-858-1602
Email - peter@bogettoandassociates.com
10805 Sunset Office Drive, Ste. 202
St Louis, MO 63127
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