Tahoe-Truckee Market Beat: All bonds won’t react the same to rising rates
July 7, 2015
Many investors are worried about what will happen to their bonds investments if and when interest rates do eventually start rising.
We've been in a long-term bull market for bonds for over 30 years now. A rising rate environment is something that younger investors have never seen.
I don't think that we have to fear a rapid rise in interest rates, but people should be aware of how their investments may react to rising rates so they can make position adjustments accordingly.
Actually, we've been in a rising rate environment since July of 2012, when the yield on the benchmark, 10-year US Treasury bonds hit an all time record low of 1.45 percent.
The Fed has not raised rates yet, but market driven rates have come up somewhat over the last few years. As of today, the 10-year Treasury is yielding about 2.3 percent.
In 1981 the 10-year Treasury yield topped out an all-time high of 15 percent.
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In general when rates rise bonds prices decline, how much they decline can be measured by a mathematical formula known as the duration. Bonds with longer maturities will fall more than shorter-term bonds.
Investment grade bonds like Treasuries have an inverse correlation to the stock market, which means that they may rise when the stock market falls.
The reason for that is what's known as "flight to safety" or "flight to quality" — there are times when investors will flee stocks and move to safer investments like Treasury bonds, which is why they often increase in value when stocks drop.
High-yield bonds typically behave more like stocks and have a positive correlation to the stock market. The reason they do is that default rates are lower when the economy is healthy. and higher in times of recession.
So, if the economy starts slipping, stocks and high-yield bonds can go down at the same time.
If interest rates are rising, it's usually because the economy is fairly strong.
Factors you need to consider if you want to evaluate your portfolio's interest rate risk are bond maturity and duration, bond credit ratings, and whether you invest in bond funds or individual issues.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information is at his blog at http://www.sellacalloption.com or 775-657-8065. The mention of securities should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals. Past performance is no guarantee of future results.
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