5 Ways To Protect Your Bond Portfolio From Rising Interest Rates
The Federal Reserve recently raised its target federal funds rate for the first time since March 2000.
This could be just the tip of the iceberg, though, as many experts believe rising inflation and a strengthening economy will spur continued rate hikes for the foreseeable future.
This is bad news for bond investors, since bonds lose value as interest rates rise.
The reason stems from the fact coupon rates for most bonds are fixed when the bonds are issued.
So, as rates rise and new bonds with higher coupon rates become available, investors are willing to pay less for existing bonds with lower coupon rates.
So what can you do to protect your fixed-income investments as rates rise?
Well, here are five ideas to help you, and your portfolio, weather the storm.Treasury Inflation Protected Securities (TIPS)First issued by the U.S. Treasury in 1997, TIPS are bonds with a portion of their value pegged to the inflation rate.
As a result, if inflation rises, so will the value of your TIPS.
Since interest rates rarely move higher unless accompanied by rising inflation, TIPS can be a good hedge against higher rates.
Because the Federal government issues TIPS, they carry no default risk and are easy to purchase, either through a broker or directly from the government at www.treasurydirect.gov.TIPS are not for everyone, though.
First, while inflation and interest rates often move in tandem, their correlation is not perfect.
As a result, it is possible rates could rise even without inflation moving higher.
Second, TIPS generally yield less than traditional Treasuries.
For example, the 10-year Treasury note recently yielded 4.75 percent, while the corresponding 10-year TIPS yielded just 2.0 percent.
And finally, because the principal of TIPS increases with inflation, not the coupon payments, you do not get any benefit from the inflation component of these bonds until they mature.
If you decide TIPS makes sense for you, try to hold them in a tax-sheltered account like a 401(k) or IRA. While TIPS are not subject to state or local taxes, you are required to pay annual federal taxes not only on the interest payments you receive, but also on the inflation-based principal gain, even though you receive no benefit from this gain until your bonds mature. Floating rate loan fundsFloating rate loan funds are mutual funds that invest in adjustable-rate commercial loans.
These are a bit like adjustable-rate mortgages, but the loans are issued to large corporations in need of short-term financing.
They are unique in that the yields on these loans, also called "senior secured" or "bank" loans, adjust periodically to mirror changes in market interest rates.
As rates rise, so do the coupon payments on these loans.
This helps bond investors in two ways:
(1) it provides them more income as rates rise, and (2) it keeps the principal value of these loans stable, so they don't suffer the same deterioration that afflicts most bond investments when rates increase.
Investors need to be careful, though.
Most floating rate loans are made to below-investment-grade companies.
While there are provisions in these loans to help ease the pain in case of a default, investors should still look for funds that have a broadly diversified portfolio and a good track record for avoiding troubled companies.Short-term bond funds
Another option for bond investors is to shift their holdings from intermediate and long-term bond funds into short-term bond funds (those with average maturities between 1 and 3 years).
While prices of short-term bond funds do fall when interest rates rise, they do not fall as fast or as far as their longer-term cousins.
And historically, the decline in value of these short-term bond funds is more than offset by their yields, which gradually increase as rates climb.
Money-market fundsIf capital preservation is your concern, money market funds are for you.
A money-market fund is a special type of mutual fund that invests only in very short-term money market instruments.
Since these instruments usually mature within 60 days, they are not affected by changes in market interest rates.
As a result, funds that invest in them are able to maintain a stable net asset value, usually $1.00 per share, even when interest rates climb.
While money-market funds are safe, their yields are so low they hardly qualify as investments.
In fact, the average seven-day yield on money-market funds is just 0.70 percent.
Since the average management fee for these funds is 0.60 percent, it does not take a genius to see that putting your capital in a money-market fund is only slightly better than stashing it under your mattress.
But, because the yields on money-market funds track changes in market rates with only a short lag, these funds could be yielding substantially more than 0.70 percent by the end of the year if the Federal Reserve continues to hike rates as expected.
Bond ladders"Laddering" your bond portfolio simply means buying individual bonds with staggered maturities and holding them until they mature.
Since you are holding these bonds for their full duration, you will be able to redeem them for face value regardless of their current market value.
This strategy allows you to not only avoid the ravages of higher rates, it also allows you to use these higher rates to your advantage by reinvesting the proceeds from your maturing bonds in newly-issued bonds with higher coupon rates.
Diversifying your bond portfolio among 2-year, 3-year, and 5-year Treasuries is a good start to a laddering strategy.
As rates rise, you can then broaden the ladder to include longer maturity bonds..
Flagship provides portfolio management services to high-net-worth individuals, corporations, and non-profit entities.
For more information, please visit www.flagship-capital.com.info@flagship-capital.com
Loans 101: Application and approval
A loan is a type of debt. Like all debts, a loan involves the re-allocation of money over a period of time between the borrower and the lender. The borrower initially receives an amount of money from the lender. This money is paid back either in full or in regular installments (with interest of course).
Acting as a provider of loans is one of the principal task for financial institutions such as a bank. For banks, loans are generally funded by deposits.
That's how banks usually earn. Their deposits are loaned out and when the borrowers pay with interest, voila! Earnings for the bank.
Other types of debt include mortgages, credit card debt, bonds, and lines of credit. A mortgage is a very common type of debt used by many individuals to purchase housing. In this arrangement, the money is used to purchase the property. The bank, however, is given the title to the house until the mortgage is paid off in full.
If the borrower is unable to pay, the...
Loans 101: Application and approval
Loans > Loans 101: Application and approval
Get that low APR mortgage fast!
Getting a mortgage is easier nowadays than it has ever been, although there are still one or two pointers you should always bear in mind when applying for a loan. Firstly, keep an eye on general interest rates - what you need to remember is that simply having a low rate does NOT make a bigger loan more 'affordable', you still have to pay off the money somehow at the end of the loan, and in these low-inflation times, a big loan now will still be a big loan in 20 years time! This is why 'interest only' loans (loans that do not require you to repay any of the capital each month) are maybe not such a great idea anymore.Interest rates tend to follow an inverse relationship to Wall street - when the stock market is rising, interest rates tend to fall and vice versa. This is because investors are always looking for the best return on their investments. If you keep an eye on the Fed rate, and the rates offered by the big Savings and Loans, you won't go far wrong. Key to understanding interest...
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A Consumer's Guide to Getting a Bad Credit Loan
Here is a useful guide to getting a bad credit loan. If you're like countless others, then you may be struggling to get a bad credit loan. You may not know where to turn, or what options are available? or even what "bad credit" actually means or how it's determined. Below are tips on how to deal with bad credit, as well as how to get a bad credit loan. What is bad credit, anyway? Obviously, if you fall behind on payments or make all of your payments late then it's going to reflect badly upon you.
New lenders aren't going to want to offer you lines of credit or financing for purchases, and will instead try to make you pay up front for everything that you buy. This is the scourge of bad credit? which means that your past late payments or non-payments have been reported to a credit agency, and they have lowered your credit score as a result. The lower your credit score is, the more of a risk lenders view you as? which is why it's so hard to get new credit lines once your credit is...
A Consumer's Guide to Getting a Bad Credit Loan
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5 Ways To Protect Your Bond Portfolio From Rising Interest Rates hearing aid
Consumers Buy Inkjet Cartridges and Laser Toner Cartridges Online in Increasing Numbers
Inkjet cartridges are the main reason why printers are so cheap these days. Printers are offered as sacrifices so that companies can sell you inkjet cartridge refills for a lifetime.The problem with this scenario is that inkjet cartridges do not cost very much to make, but the printer companies will sell them to you for a huge profit because they know that you are stuck with buying their inkjet cartridge replacements for the life of your printer. This can mean hundreds of dollars in profit over...
5 Ways To Protect Your Bond Portfolio From Rising Interest Rates Loans Consumers Buy Inkjet Cartridges and Laser Toner Cartridges Online in Increasing Numbers online degree
Loans > Consumers Buy Inkjet Cartridges and Laser Toner Cartridges Online in Increasing Numbers
5 Ways To Protect Your Bond Portfolio From Rising Interest Rates Loans
5 Ways To Protect Your Bond Portfolio From Rising Interest Rates Loans
5 Ways To Protect Your Bond Portfolio From Rising Interest Rates Loans
5 Ways To Protect Your Bond Portfolio From Rising Interest Rates