A common question that we get from our clients is how to invest in bonds in today’s market, given the trend of rising interest rates. It has been one of our more difficult investment challenges over the past five years. The heart of the problem is simple: during a period of rising rates, the value of existing bonds (with comparatively lower interest rates) that we hold go down. How to appropriately manage existing bond portfolios from rising rates?
Interest rates have been rising. By way of example, the 10 Year US Treasury Bond was recently trading at a yield of 3.16%. Exactly one year ago in October of 2017, the yield on the 10 Year US Treasury Bond was 2.28%. In a year’s time, interest rates on the 10 Year are nearly 1% higher. This is a relatively large shift on a percentage basis, with the 10 Year yield growing by 38% over the course of just twelve months.
We are keenly aware of the problems associated with rising rates. Accordingly, individuals should consider holding bonds with less interest rate exposure than the broad bond index, the Barclays US Aggregate Bond Index. The Barclays US Agg has a duration of approximately six years. Without getting too technical, a bond’s duration is its sensitivity to interest rates. A duration of 6 means that if interest rates were to rise by 1%, the price of the bonds would fall by 6%.
In some ways, we actually welcome the rise in interest rates that has occurred over the past few months. When yields are rising in a period of economic growth, it is a good thing. With higher yields, we create higher expected returns from our bonds. Whereas last year bonds were yielding well below 3%, today they are well above 3%. All else being equal, higher interest rates are a net positive for savers and for retirees.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. All investing involves risk including loss of principal. No strategy assures success or protects against loss.