What Happens to My Bonds When Interest Rates Rise?

 What Happens to My Bonds When Interest Rates Rise?

 

We know that ta. And the short answer to the question "what will happen to my bond portfolio when interest rates rise?" is simply this: it depends. And the reason this depends is because not all titles are created equal. Some securities have very high levels of interest rate sensitivity. These may be long-term securities, 30 years or more. Other securities have little sensitivity to interest rates.

Maybe it's a one-year bond or a two-year bond. And the key when it comes to managing a portfolio of bonds is to combine the bonds you hold with your goals. Most individuals will find that their goals are best suited for short- and medium-term bonds. Maybe these are from one year to ten years. Other individuals may hold long-term bonds, but this comes with the perception that they will be more susceptible to rising interest rates. When interest rates rise, however, there are two impacts on a portfolio of securities. The first is that, in the short term, prices fall. As interest rates rise, bond prices fall. But the second impact is sometimes hidden, and it's simply this: over time in a growing interest rate environment, a portfolio's revenue increases. This is because bonds are constantly maturing or the beginning of income streams in the form of coupon payments. As this income and these maturities are reinvested at ever higher interest rates, the yield on your securities portfolio increases.

And what many people may discover is that, over an interest cycle, the trajectory of their securities portfolio will be something like a U. Initially, the value will decrease as bond price losses outweigh any gains in revenue . But over time these higher levels of income compensate for price declines and result in a net asset value, or a value in your securities portfolio, perhaps equal to or greater than where you started. Ultimately, in fact, raising interest rates is a friend of the investor because of this: an investor has the option of getting a loss on a securities portfolio if it is due to an increase in interest rates.


And what I mean by that is that when a security becomes defaulted, if it is a lower credit quality, an investor has no choice whether or not to recognize the loss. And this loss is a permanent loss of your capital. But with interest rates, due to the fact that bond revenues can be reinvested in the portfolio, interest rate movements are self-correcting. Investors have the option of recognizing losses or not. And if they do not recognize their losses, then any temporary decline is simply this: a temporary loss of their capital. And so rising interest rates are nothing to be feared, as long as the average maturity and composition of your bond portfolio matches your goals. If your time horizon and your financial goals match your bond portfolio, in fact, raising interest rates is your friend. Think of it this way. What will provide more income: higher interest rates or lower interest rates? The answer, of course, is self-evident. And if you have a financial goal that involves getting a certain required rate of return, the higher interest rates will bring you closer to that financial goal. And that's why starting with a financial plan that identifies your goals, following with a portfolio of titles - if you have titles, if they are appropriate for you - matches your goals, and then keeping track of those high quality titles is the best thing that most investors can do and will give them the greatest opportunity to reach their financial goals.

Then again, the increase in interest and part of the rhetoric that comes from it, especially in the media, part of the paranoia, some of the hyperbole - can sometimes lead to the fear that, "Oh my God, my securities portfolio will collapse in value ". But the truth is that if your bonds are short and intermediate, and if they suit your time horizon, rising interest rates will be your friends, not your enemies, and increase your chances of finding your finances. goals.

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