Over the past three decades, interest rates have steadily declined. Both corporations and consumers have enjoyed refinancing their debt (bonds and mortgages) at historically low rates. Our low interest rate environment is beginning to normalize, since May, rising interest rates have investors witnessing an attribute of bond investing: as interest rates rise, bond prices generally move in the opposite direction. Does this mean an investor should avoid bonds? No, in fact there are many positives of rising rates.
When interest rates rise bond prices will fall. However, most bonds will repay the owner their original investment (par value) at maturity and investors are able to reinvest their coupon payments at higher interest rates. In addition to receiving par and reinvesting at higher rates, the most recent rising interest rate periods have been associated with improving economic conditions, higher equity returns and bond total returns.
Our clients’ portfolios are specially designed to have an intermediate term (5-7 years) interest rate risk profile; history has shown this range to capture most of the returns while mitigating some downside risks. We allow our bond mutual fund managers flexibility to manage their interest rate risk as they deem prudent for the market environment and strategy. During this time of interest rate transition, we feel it is important to let you know that we continue to believe that the traditional role bonds have played in the past, diversification and income, is still relevant.
Any opinions are those of Mark Smith and not necessarily those of Raymond James. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Bond prices and yields are subject to change based upon market conditions and availability. If bonds are sold prior to maturity, you may receive more or less than your initial investment. There is an inverse relationship between interest rate movements and fixed income prices. Generally, when interest rates rise, fixed income prices fall and when interest rates fall, fixed income prices rise. Diversification and asset allocation do not ensure a profit or protect against a loss. Prior to making an investment decision, please consult with your financial advisor about your individual situation.