During the past several years, we’ve witnessed historically low interest rates. However, while it’s impossible to predict how long interest rates will stay low, many economists believe the current low rate environment is unsustainable. We’ve even recently seen an uptick in interest rates. With this in mind, it is important for bond investors to have an understanding of how their investments could be impacted during a rising interest rate environment.
Why the Federal Reserve Adjusts Rates – The Federal Reserve’s Federal Open Market Committee (FOMC) determines the direction of our nation’s monetary policy. It is responsible for setting the federal funds rate, the rate banks charge each other for overnight loans. The FOMC may see fit to lower rates to help stimulate the economy or raise interest rates in order to keep inflation under control.
Effects of Interest Rates on Bonds – As interest rates change, so do the values of existing bonds. Bond prices move inversely to interest rates; when interest rates fall, the prices of outstanding bonds generally rise. When interest rates rise, the prices of outstanding bonds typically fall in order to bring the yield of older bonds into line with the higher interest rates offered by new issues. The longer a bond’s maturity and the lower its coupon rate, the more it will be affected by a change in interest rates.
Rising rates will not have an effect on the income you receive from your bonds or your bonds’ maturity value, for when a matured bond is redeemed, you will receive back the face (par) value of the bond. However, it is important to note that if you sell your bonds prior to maturity, and interest rates have gone up, the value of the bond you are selling may have decreased, and you may have to sell it at a loss.
Talk With Your Financial Professional – Many investors have flocked to bonds in recent years looking for yield and for what they believe is a degree of safety and stability. While bonds can play an important role in any portfolio, it is critical that you familiarize yourself with how interest rate movement can impact your bonds – whether individual bonds or bond mutual funds. Will you be prepared should interest rates go up? For more information on how your bond investments could be affected, contact your financial professional today.
Jana Swenson is a Vice President/Investments with Stifel, Nicolaus & Company, Incorporated, member SIPC and New York Stock Exchange, and can be reached by calling the firm’s Murrieta, California office at (951) 461-7220 or toll-free at (866) 894-2461.