If you are like a lot of folks I’ve talked with recently you may be worried about the interest you are earning on your fixed investments. Your CDs and IRAs may be maturing and the interest that you will begin drawing on them is likely to be much less. You do not want to invest that money in something risky; however, the best you can earn is 1.0%.
The above scenario has forced a lot of investors into the bond market; however, with interest rates near record lows many think it’s time to exit the bond market. Bonds can provide predictable income and principal protection. The problem with bonds is that rising interest rates are destructive to fixed income portfolios because when interest rates rise – bond prices fall… and sometimes the moves can be dramatic.
Consider some of the conditions that typically lead to higher rates:
- Stronger economic growth
- Rising inflation
- Growing expectations that the Federal Reserve will raise short-term rates
- Elevated risk appetites prompting investors to sell safer fixed-income investment and buy higher-risk investment
The good news is that there are investments that can be used to “hedge” against the potential destruction caused by rising interest rates. Consider adding the following to your fixed-income portfolio.
Floating Rate Bonds
Unlike traditional bonds that pay a fixed rate of interest, a floating rate bond has a variable rate of interest that resets periodically. The advantage of floating rate bonds is that interest rate risk is largely removed from the equation and that floating rate bonds will pay higher yields if rates go up.
Short Term Bonds
Short term bonds can help provide safety when rates start going up because their maturities are closer and the odds of a substantial rate increase is less during a shorter period of time.
High Yield Bonds
Even though high yield bonds are riskier than investment grade bonds, they can hold up well when rates are rising because they tend to pay higher yields than other bonds with similar maturities.
Convertible bonds are bonds that can be converted t shares of the issuing companies’ stock. This makes convertible bonds more sensitive to stock market movements than a typical bond and there is a greater likelihood they can go up in price when traditional bonds are under pressure from rising rates.
Consider adding some of the above investments as you strive to construct a well-diversified portfolio. Before investing in any of these options, be sure to discuss the relevant risks and rewards with your financial advisor. A number of investment strategies can be tailored to meet your individual needs.
The return and principal value of bonds fluctuate with changes in market conditions. If bonds are not held to maturity, they may be worth more or less than their original value. The value of bonds will decline as interest rates rise.
Traditional CD's are insured by the NCUA and offer a fixed rate of return, whereas both the principal and yield of investment securities will fluctuate with changes in market conditions."
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Founders Financial Group, LLC and Founders Insurance Services are not
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Main Street, Lancaster, SC 29720; 1290 Old Springdale Road, Rock Hill,
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This article was written by C. David Tolson, III with Founders Investment Services. It was published in Founders Open Exchange Newsletter (July 2013).