| |
| |
|
|
|
|
|
5 Ways To Protect Your Bond Portfolio From Rising Interest Rates
The Federal Reserve recently raised its target federal funds rate for the first time since March 2000. This could be just the tip of the iceberg, though, as many experts believe rising inflation and a strengthening economy will spur continued rate hikes for the foreseeable future. This is bad news for bond investors, since bonds lose value as interest rates rise. The reason stems from the fact coupon rates for most bonds are fixed when the bonds are issued. So, as rates rise and new bonds with higher coupon rates become available, investors are willing to pay less for existing bonds with lower coupon rates. So what can you do to protect your fixed-income investments as rates rise? Well, here are five ideas to help you, and your portfolio, weather the storm. 1. Treasury Inflation Protected Securities (TIPS) First issued by the U.S. Treasury in 1997, TIPS are bonds with a portion of their value pegged to the inflation rate. As a result, if inflation rises, so will the value of your TIPS. Since interest rates rarely move higher unless accompanied by rising inflation, TIPS can be a good hedge against higher rates. Because the Federal government issues TIPS, they carry no default risk and are easy to purchase, either through a broker or directly from the government at www.treasurydirect.gov. TIPS are not for everyone, though. First, while inflation and interest rates often move in tandem, their correlation is not perfect. As a result, it is possible rates could rise even without inflation moving higher. Second, TIPS generally yield less than traditional Treasuries. For example, the 10-year Treasury note recently yielded 4.75 percent, while the corresponding 10-year TIPS yielded just 2.0 percent. And finally, because the principal of TIPS increases with inflation, not the coupon payments, you do not get any benefit from the inflation component of these bonds until they mature. If you decide TIPS makes sense for you, try to hold them in a tax-sheltered account like a 401(k) or IRA. While TIPS are not subject to state or local taxes, you are required to pay annual federal taxes not only on the interest payments you receive, but also on the inflation-based principal gain, even though you receive no benefit from this gain until your bonds mature. 2. Floating rate loan funds Floating rate loan funds are mutual funds that invest in adjustable-rate commercial loans. These are a bit like adjustable-rate mortgages, but the loans are issued to large corporations in need of short-term financing. They are unique in that the yields on these loans, also called "senior secured" or "bank" loans, adjust periodically to mirror changes in market interest rates. As rates rise, so do the coupon payments on these loans. This helps bond investors in two ways: (1) it provides them more income as rates rise, and (2) it keeps the principal value of these loans stable, so they don't suffer the same deterioration that afflicts most bond investments when rates increase. Investors need to be careful, though. Most floating rate loans are made to below-investment-grade companies. While there are provisions in these loans to help ease the pain in case of a default, investors should still look for funds that have a broadly diversified portfolio and a good track record for avoiding troubled companies. 3. Short-term bond funds Another option for bond investors is to shift their holdings from intermediate and long-term bond funds into short-term bond funds (those with average maturities between 1 and 3 years). While prices of short-term bond funds do fall when interest rates rise, they do not fall as fast or as far as their longer-term cousins. And historically, the decline in value of these short-term bond funds is more than offset by their yields, which gradually increase as rates climb. 4. Money-market funds If capital preservation is your concern, money market funds are for you. A money-market fund is a special type of mutual fund that invests only in very short-term money market instruments. Since these instruments usually mature within 60 days, they are not affected by changes in market interest rates. As a result, funds that invest in them are able to maintain a stable net asset value, usually $1.00 per share, even when interest rates climb. While money-market funds are safe, their yields are so low they hardly qualify as investments. In fact, the average seven-day yield on money-market funds is just 0.70 percent. Since the average management fee for these funds is 0.60 percent, it does not take a genius to see that putting your capital in a money-market fund is only slightly better than stashing it under your mattress. But, because the yields on money-market funds track changes in market rates with only a short lag, these funds could be yielding substantially more than 0.70 percent by the end of the year if the Federal Reserve continues to hike rates as expected. 5. Bond ladders "Laddering" your bond portfolio simply means buying individual bonds with staggered maturities and holding them until they mature. Since you are holding these bonds for their full duration, you will be able to redeem them for face value regardless of their current market value. This strategy allows you to not only avoid the ravages of higher rates, it also allows you to use these higher rates to your advantage by reinvesting the proceeds from your maturing bonds in newly-issued bonds with higher coupon rates. Diversifying your bond portfolio among 2-year, 3-year, and 5-year Treasuries is a good start to a laddering strategy. As rates rise, you can then broaden the ladder to include longer maturity bonds. David Twibell is President and Chief Investment Officer of Flagship Capital Management, LLC, an investment advisory firm in Colorado Springs, Colorado. Flagship provides portfolio management services to high-net-worth individuals, corporations, and non-profit entities. For more information, please visit www.flagship-capital.com.
MORE RESOURCES:
Investing - Google News |
|
|
|
RELATED ARTICLES
Stocks: Reduce Risk Yet Maximize Profits It is important to note that every smart investor wants to minimize risk while maximizing profit potential. Yet conventional investment theory tells us that in order to increase returns, you have to increase risk. Moving Average Convergence Divergence ( MACD ) Charts The Moving Average Convergence Divergence charts, or MACD charts for short, are a technical indicator that is derived from the more simple moving average.The MACD charts are oscillating indicators, meaning that they move above and below a centerline or zero point. Wit and Wisdom on Money, Wall Street and Success - Part #4 Can you concisely summarize your investment philosophy in a few sentences? My experience is that most people can't. The quotes that follow are diamonds that offer a real powerful education in the world of Risk Management. Property Investment Just Got Exciting There is an area in Brazil that has lower crime & lower property prices than where your are probably sitting right now!Demand from the increasing retirement population and from those who have benefited from their own property markets are now pushing overseas property prices up. Brazilian property prices are still very low and offer the overseas property buyer quality real estate in stunning locations. Short Selling for Investors Shorts. Let's see. Wit and Wisdom on Money, Wall Street and Success - Part #2 Here are ten more WISDOM packed GEMS that ooffer very unqiue insights to the world of trading and investing.These quotes promote a philosophy which is readily understandable and sometimes hysterical. Use of a Franchise Business as a Family Tax Planning Strategy Suggesting the use of a franchise business as a vehicle for family estate and tax planning. Specifically using as an example, The Car Wash Guys, a portable car wash franchise, where you will be purchasing a completely designed and outfitted car wash truck and the right to develop a specific city or regional area with out of pocket start-up costs between $25-50,000. Trading Tips No 7: Developing a Casino Mentality for the Day Trader I submit that the successful day trader would profit well to adopt a casino mentality. At first glance, this sounds reckless and nothing more than a gambling attitude - but it's not. Help with My Annuity The cries are heard from the distance, "I need help with my annuities." Nothing has changed. Use this Simple Trick its to Buy $100 Bills Direct from your Bank for only $97 Most People just don't understand the power of using their home as a Wealth Creation Tool. How many people do you know who have lived in the same house for 10, 15 or more years and have virtually no mortgage, You know the Type 'House Rich Cash Poor'. Investing & Online Stock & Share Trading: Money & Risk Management - Atkinson Portfolio Planner (1) This article was originally featured in Daryl Guppy's 'Tutorials in Applied Technical Analysis', voted no 1 trading newsletter in Australia by Shares magazine & no 4 in the world by US Stocks & Commodities magazine and is reprinted here with Daryl's permission.In addition to developing sound technical analysis skills, strong trading psychology coupled with well thought-out money and risk management are also vital key secrets for success when trading or investing in the market. Scots Beat Yanks in China Bank Deal With visions of an ATM in every neighborhood in China, foreign banks and investment firms are queuing up to join the "China Club."Moneybags CommunismThe initiation fee for the "China Club" is straightforward and pure moneybags communism: invest cold hard cash in its largely insolvent state-owned banks, put your reputation on the line, reassure nervous foreign investors about upcoming IPO's, and share your risk management, corporate banking and other expertise with eager Chinese executives. The Benefits of Laddering Your CD Investments If you've decided to stock some money away in a certificate of deposit, why not reap the highest benefit over time by laddering your CD investments? What's a CD latter? I'm glad you asked.A CD ladder is made up by purchasing several CD's at one time with different maturity dates. The Dreaded Direct Question (Please have a glass of water within reach before reading this article.)Your personal financial planning is the topic of discussion here today, but not quite yet. Shop More, Save More for College Gimmick or Reality? The man sat in a chair beside a dressing room at a Tampa, Fla. maternity store. Your Portfolio and "Old Ironsides" The USS Constitution first ventured into the waters in 1798. From there she became an icon of durability and success. Emotions: A Traders Worst Enemy; Get Rid of Fear and Greed - Youll be Glad You Did You hear it over and over and over in books, forums, and chatrooms. Fear and greed, fear and greed, fear and greed. To Retire Rich, Save and Invest Early If you want to retire rich, start saving investing early. The most powerful tool when it comes to retiring rich, is compounding your returns on money saved when you are young. Asset Allocation: Critical to Your Investment Success Asset allocation is a critical component of investing success. Both research and academic studies show asset allocation to be single most significant factor in determining your financial goals. Reading Between The Lines In Annual Proxy Statements Upper Saddle River, N.J.
|
