If you have bonds in your portfolio here’s a topic that might have special interest to you.
On June 14 the Federal Reserve voted to increase interest rates by ¼%, the 4th rate hike since the Fed began to end its abundant monetary stimulus program.
With more rate hikes expected to come this year, and three additional hikes in 2018 and 2019, we have entered a new era of steadily rising rates following a 30-year-period of a declining rate environment.
So what does this have to do with bonds? If you are a bond holder, it is important to understand that when interest rates increase, bond prices decrease. So although the interest you receive on your bonds will be unchanged, the value of your bonds will decline with each rate hike. A single quarter point increase to the Fed’s benchmark rate will not dramatically alter your returns, but a prolonged campaign of rate increases will translate to steady deterioration in the principal amount of your bonds.
At OnCenter Financial we are aware this rising rate environment requires a new strategy for the bonds in your portfolio, and recommend bonds with short-term maturities that are least sensitive to interest rate increases and will suffer the least amount of price deterioration. I also advise my clients to consider buying individual bonds, as you can always hold them to maturity and never suffer any loss of principal. In fact, building a bond ladder of individual bonds having chronologically increasing maturity dates can be a valuable technique in this financial environment.
I do not advise investing in long-term bonds for two important reasons
1) they will suffer the greatest price deterioration, and 2) you don’t want to lock in a 30-year-rate at these current low levels if we know that more lucrative returns will be available with each Federal Reserve rate hike.
Though interest rates are on the rise, they will still remain low in relative terms based on long-term averages. Right now let’s work together to take the appropriate steps to avoid loss of principal that will result from each successive rate increase.