August, 2014
What Rising Interest Rates May Mean to You
Speculation is ongoing about when the Federal Reserve will begin hiking short-term interest rates. While the central bank has kept short-term rates near zero since December 2008, at the most recent policy meeting, Fed Chairwoman Janet Yellen indicated that with continued signs of economic improvement, higher rates could come in 2015. With higher rates on the horizon, you might be wondering how your investment portfolio could be affected.
Individual Bonds (1)
Generally speaking, rising interest rates lower the value of bonds that investors currently hold. This is because investors can now buy similar bonds with the same maturity by paying a higher rate, which lowers the value of existing bonds. But for investors who hold their bonds until maturity, rising rates are not necessarily cause for worry. Price fluctuations do not affect a bond's coupon payment and should not affect the ability to pay back principal at maturity. Some investors may choose short-term bonds to limit their exposure to price fluctuations.
Rising interest rates can also provide investors the chance to reinvest in bonds offering higher yields. If you seek a balance between low price fluctuations and higher yields, consider choosing a mix of short-, intermediate-, and long-term bonds.
Bond Mutual Funds (2)
A bond fund's value also fluctuates as the prices of its individual holdings change. And because, unlike individual bonds, bond funds do not have a specific maturity date, principal risk cannot be minimized by holding to maturity. In other words, if interest rates rise, there is a chance that the bond fund's total return will be lower. Yet because they continuously buy and sell holdings, bond funds have the potential to offer instant diversification. (3)
Stocks and Stock Mutual Funds (4,2)
Prices of individual stocks and stock funds may decline as interest rates rise, as higher rates make bond investments more appealing. Higher interest rates can also negatively affect corporate earnings in some industries, such as utilities and financial services, potentially causing those stocks to decline. But some stocks may be less sensitive to interest rates because of other factors, including new technologies, currency exchange rates, and corporate management changes.
Since stocks and bonds generally do not tend to move in lockstep, the best way to insulate your investments against interest rate risk may be to diversify between both types of investments. Diversifying may also help to stabilize your portfolio during times of market volatility. (3)
1 - Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and are subject to availability and change in price.
2 - Investing in mutual funds involves risk, including loss of principal. Mutual funds are offered and sold by prospectus only. You should carefully consider the investment objectives, risks, expenses and charges of the investment company before you invest. For more complete information about any mutual fund, including risks, charges and expenses, please contact your financial professional to obtain a prospectus. The prospectus contains this and other information. Read it carefully before you invest.
3 - There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not ensure against market risk.
4 - Investing in stocks involves risks, including loss of principal.
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August 2014 This column is produced by the Financial Planning Association, the membership organization for the financial planning community. It has been modified and is provided by Thomas A. Fisher, a local member of the FPA.
The material presented is believed to be from reliable sources and we make no representations as to its accuracy or completeness. All information and ideas should be discussed in detail with your own adviser prior to implementation in order to determine whether the strategies mentioned are appropriate for your specific situation.