Should We Worry About Rising Interest Rates?

Should We Worry About Rising Interest Rates?

The math of bonds is as follows:  When interest rates go down (like they have now for such a long period) bond prices rise and investors can enjoy capital gains in addition to interest payments.  Conversely, when interest rates rise, bond prices fall and investors can incur capital losses often much larger than the interest they may receive.  The greater the number of years until the bond matures, the greater the risk. 

In other words, short-term bonds (2-3 years or less) will mature soon and therefore rising rates can’t affect prices all that much.  Long-term bonds, on the other hand, move dramatically when interest rates change.  

I worry that most retail bond investors today have no idea of the inherent risk in their fixed-income portfolios.  I feel they will be shocked and pained should interest rates rise. 

The last thing the government wants is for interest rates to rise.  So much so they are printing enormous sums of money just to keep interest rates low.  We could very well reach a point where the government loses control of bond prices and interest rates could sharply rise. 

This could happen soon, or it could happen a long time from now.  Regardless, we are very worried about this.  To protect our clients from rising interest rates, we have kept our client’s fixed-income investments very short-term.  

 Excerpt from the article:

But the Fed has only limited power to control interest rates. And sharply higher yields would be far from unusual. For instance, 30-year Treasury bond yields are currently under 3 percent. As recently as last year, they topped 4.5 percent, and in early 2000 they briefly exceeded 6.5 percent. Because of the long maturity, a single percentage point rise in rates would translate into roughly a 20 percent decline in the value of long bonds.

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