Taking a Boy Scout approach to bonds

Taking a Boy Scout approach to bonds

Thanks to their low risk and steady returns over the past decade and beyond, bonds and bond funds have garnered a well-deserved reputation as a safe investment in a world where little ever feels safe. That safety comes as a direct result of the inverse relationship most bonds have with interest rates.

Thus, when interest rates go down, as they have done quite steadily since the mid-1980s, bond prices go up. Because this trend has been in effect for so long, many current investors have no recollection or knowledge of a time when double-digit losses on bonds weren’t uncommon. But the time for remembering — and being prepared for change — might just be upon us.

Interest rates on bonds have recently ticked back up. A good example is the yield on the 10-year Treasury which earlier this summer went below 1.4 percent, now sits near 1.7 percent.

While still remarkably low, a continued uptick in rates could have many investors facing their first-ever negative returns on bond holdings and others recalling much rockier bond times.

Now is the time to prepare.

The good news is that bonds aren’t quite as mercurial as stocks. The wild, weekly swings that you might see in the stock market rarely happen in the bond market. That’s good news as the slow pace allows you to prepare with patience. Developing a thoughtful game plan will enable you to proactively position investments if and when a significant bond market move occurs.

Part of your plan should involve looking at your portfolio and determining which investments are at most risk if interest rates continue to rise.

Consider your mix of bonds, as well. Typically, the shorter the maturity of the bond the less fluctuation of price you will see. But if all your bond funds are long-term (20 year-plus maturities), it may be time to start thinking about moving some of that money into shorter maturity bonds and bond funds.

It’s also important to note that not all bonds react the same way to rising interest rates. Some bonds, including Floating Rate Funds, High Yield bonds, and Emerging Market bonds, are more economically sensitive than interest-rate sensitive, meaning they tend to increase in value during periods of rising interest rates. Give consideration to the nature of your bond before you do any shuffling.

You also want to look at any bonds connected to your 401k. If your 401k is loaded up on bond funds, you may want to consider a Stable Fund option. A built-in option in most 401ks, Stable Funds offer a guaranteed interest rate option. While not typically a very high rate, a low steady rate is certainly better than a negative return.

Regardless of what steps you do or don’t take, the most important thing is to simply be prepared. If the market stays steady and your bonds continue to perform, all will be well. But if things start to turn, you’ll be ready to make the changes that could secure your financial future.

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