There is an often repeated story in investment media about how bad rising interest rate environments are for bonds. “When interest rates increase, bond prices fall”
Sayings like this cause many investors to unnecessarily pull out of the market as they don’t dig a little deeper into what bonds are and their purpose. Loss of price = bad = sell is the thought process.
It’s true. Bond prices fall as interest rates rise. This means many short term investors get jittery and panic. But’s let not forget the importance of bonds and why you were holding them in the first place. They are a shock absorber for your investment portfolio. They limit the damage in periods of poor stock performance.
In addition to this, bond prices are just one part of the returns when investing in bonds. The other part is interest rates. Otherwise known as your coupon rate. So assuming bond prices are falling, your interest rate doesn’t change if you hold to maturity. You will still receive that higher interest rate if you don’t sell. Not only that, but if you are buying bonds every month as part of an overall investment plan, then each month you are buying new bonds at higher interest rates than if interest rates were decreasing.
Personally, I wouldn’t let changes in interest rates drive my bond buying decisions.
It is your investment goals that should shape your asset allocation decisions. And when investing in stocks and bonds, it is the long term focus that matters. Making decisions reacting to todays happenings is a recipe for sub par returns. Today’s happenings are already priced into the market anyway. You are not a guru who knows something that the crowd doesn’t.
As a monthly investor I welcome higher interest rates for my bonds. Sure, it makes my current holdings worth less, but my future contributions will remain positive. That is the benefit of holding a wide range of bonds of varying durations.
Not only that, but higher interest rates tend to mean a better performing economy. Interest rate increases typically mean an expanding economy. Typically in this environment, you will see less companies defaulting on the debt.
Rising interest rates are not necessarily the ‘boogeyman’ for your bond investments. Before altering your investment approach or fleeing for the exits in reaction to the economy or the news media, maybe check on your reasons for doing so and if it is in your long term best interest.
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The information contained on this site is the opinion of the individual author(s) based on their personal opinions, observation, research, and years of experience. The information offered by this website is general education only and is not meant to be taken as individualised financial advice, legal advice, tax advice, or any other kind of advice. You can read more of my disclaimer here