Is It Time to Rethink Your Bond Holdings?
This year we have experienced surprisingly low volatility, which can be attributed to the monetary policy and a benign credit cycle. The low interest rate environment that we've had has really had an impact on the financial markets. As you are most likely aware, the Quantitative Easing policy is coming to an end next month and this is the Fed’s way of saying the economy is improving. However, the next step will be for interest rates to rise and most economists are predicting interest rates will begin rising the middle of next year.
Most people think of bonds as fixed income and a lower risk, and for those of you who have bonds, you are looking for a reasonable level of security. So, where do you go for this income? You go to the bond market, but treasuries yielding 1% or 2% do not get you very far, so you may have looked at getting this income by purchasing higher yielding bonds. In a rising interest rate environment, bonds become a higher risk, and the value of the bond will drop. If you have long-term bonds, in general, the more you can lose and if you have short term bonds, in general, the less you can lose.
Why does this impact you? By investors looking for income and turning to investment grade and high-yield bonds, the rate risk those investments involve could lead to a loss of principal. Generally speaking, when interest rates rise, bond values will go down. To put it in perspective, let’s say you purchased a bond for $1,000 at an annual yield of 4% (its coupon rate), but yields on bonds of that maturity and quality have now risen to 5%. When you try to sell the bond, no one will pay the $1,000 that you paid to earn a 4% yield when they can receive a yield that is 25% higher. To make your bond equally attractive, you must lower the price.
Maybe now is the time for you to come in to get a stress test on your portfolio to identify your risk exposure. To speak to a retirement planning specialist, give our office a call at (775) 853-9033.