Historically speaking, bonds and bond funds have been a good bet as a more secure option in counterpoint to the stock market. For the last 30 years yields have been up and interest rates have been steadily going down down down.
It seems, however, that we’ve reached the bottom of that barrel. This year we saw interest rates go UP for the first time in ten years after the Federal Reserve voted to raise the rates. There was also another rate hike scheduled for later this year, with even steeper increases proposed for 2017.
The brakes were applied after news of the UK’s possible retreat from the European Union, low oil prices, and slow economic growth in China weakened our economy’s already shaky legs. So while it looks like bond funds have dodged the bullet, for now, it’s safe to say that increasing interest rates looks like a trend that’s here to stay. We just don’t know when or how fast the rates will rise.
Why does this matter?
Bonds have an inverse relationship to interest rates: they perform best when interest rates are moving lower, and worse when interest rates are moving higher. This is particularly meaningful to the investor who holds bond funds because bond funds hold many different kinds of bonds. If your money is tied up in a low-interest bond fund when the new higher-interest bonds become available, then the value of the fund falls.
Uh-oh, spaghettio.
Bond funds are often sold by financial advisors or brokers as a safer alternative to stock market funds, but they have NO maturity date (unlike an individual bond) and NO date when you can count on getting your money back. That means NO principal protection. For investors who thought they were getting a safe investment by purchasing bond funds, all those NOs could mean trouble.
It’s also common to see bond funds offered in variable annuities, which can make things even more confusing because these products are often sold with contractual guarantees that many investors mistake for rate guarantees. When interest rates go up again, those bond funds could start losing more money, and you could get another bad surprise from your variable annuity.
So how do you avoid this? In a rising-interest-rate environment, you want to look for two things:
First, look for investments that have stability.
If you are nearing retirement especially, you will want to get an element of protection built into your portfolio. A lot of people are confused about the best way to do this, but every situation is a little bit different which means there’s no one-size-fits-all solution to this problem.
Second, look for investments with a set maturity date.
Individual bonds have set maturity dates after which you can get back everything you put into the investment, plus the promised interest rate payments. That’s one example of principal protection plus growth, the only problem is, some individual bonds take 20 to 30 years to mature. If you need your income before that time, you’ll want to look for something that can give you principal protection within a shorter time frame.
Those investments do exist. You don’t’ have to stay in bonds during retirement in order to protect your income. In fact, if bond funds are your only source of income during retirement, then your income and principal will likely be in jeopardy during the next 10 years as interest rates change. You do have other options, and now might be a good time to take a look at what those options are before rates go higher and your fund starts losing.
If you have questions about how to get the stability and guarantees your portfolio needs, feel free to reach out to us. We can answer any questions you might have with NO pressure, NO hype, and NO shenanigans so you can retire with NO worries. Now, these are the kind of No’s a person can feel good about.
