Download the Schwab app from iTunes®Get the AppClose

4 Things to Consider When Interest Rates Rise

Click to show the transcript

KATHY JONES: There hasn’t been a lot of good news for bond investors so far this year. Even though long-term yields have pulled back from the peak in early February, inflation is still picking up, the Federal Reserve is hiking short-term interest rates, and markets have been really volatile. Consequently, the returns in many segments of the bond market have been very low or even negative year-to-date. Not surprisingly, we’ve been getting a lot of questions from investors about how to manage their bond portfolio in this kind of environment. I’m Kathy Jones, and this is Bond Market Today.

Here’s a question we’ve been getting a lot recently: "How do I manage my fixed income investments when interest rates are rising, because when interest rates go up, bond prices tend to go down?" Fortunately, there are some steps that you can take to help mitigate some of the risks in the market right now. I’m going to suggest four things to consider.

The first is consider TIPS, Treasury Inflation-Protected Securities. TIPS bonds are bonds issued by the U.S. Treasury that have an adjustment factor, so that the coupon payments and the principal will adjust every year based on the rate of inflation, and they use CPI, Consumer Price Index, to make that adjustment. So over time, they’re designed to keep pace with inflation. Now, TIPS are still bonds, they will still fluctuate with the ups and downs in interest rates, but as opposed to nominal Treasury bonds, they’re designed to not lose ground to inflation over time.

A second suggestion is to consider floating-rate notes. Floating-rate notes usually have very short-term durations, and their coupon payments, or the investment income that you earn, tends to adjust on a very short-term basis if short-term interest rates are rising, as they are currently. There are two major kinds of floating-rate notes: One is investment-grade, and the other are bank loans. As the name suggests, the investment-grade floating rate notes are usually issued by corporations that have higher credit quality, while the bank loans are usually loans made to companies that are lower in credit quality, who are usually below investment-grade, or junk-rated, as we refer to them often. That’s a really important distinction and one that you should take into consideration when investing. But year-to-date, floating rate notes have been one of the better-performing parts of the bond market with short-term interest rates moving up.

A third suggestion is something we’ve talked about many times in the past, and that’s bond ladders. With bond ladders you stagger the maturities of your portfolio over time, and that gives you a portfolio that’s generating income, but also some flexibility to reinvest because you always have a bond … you know, frequently will have a bond maturing at a regular basis that you can invest if interest rates go up and generate more income over time. The other thing with a bond ladder is it takes the decision-making about timing the market out of your hands. So you’re always invested in the market, but you’re not trying to figure out when bond yields are going to peak, or, you know, how high they’re going to go. It just keeps you invested, but it does give you some flexibility along the way.

And our fourth suggestion is very simple. Just consider some high-quality short-term bonds for the portfolio. That should help diminish the overall volatility in your investment portfolio. Short-term high-quality bonds, like very short-term Treasury notes of, you know, like maturities of a year or two, tend to have very low volatility. And that means that overall it could balance against some of the more volatile investments that you might have in your portfolio. Also, because short-term interest rates have been going up, there’s actually a yield on those these days, as opposed to when we were in the zero-interest-rate environment.

So, overall, it is a challenging market environment, but there are some things that you can do to help manage the volatility and interest rate risk in your portfolio. And keep in mind that as interest rates rise, we’re going to get some opportunities to invest to generate more income in a portfolio.

If you would like to learn more about the bond market or investing in fixed income, you can go to Schwab.com, click on the Insights & Ideas tab and go to fixed income, or you can follow me on Twitter @KathyJones. Thanks for watching.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

Please note that this content was created as of the specific date indicated and reflects the author’s views as of that date. It will be kept solely for historical purposes, and the author’s opinions may change, without notice, in reaction to shifting economic, market, business, and other conditions.

Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. Supporting documentation for any claims or statistical information is available upon request.

Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance.

Schwab Center for Financial Research (“SCFR”) is a division of Charles Schwab & Co., Inc.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed-income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Lower rated securities are subject to greater credit risk, default risk, and liquidity risk.

Treasury Inflation Protected Securities (TIPS) are inflation-linked securities issued by the US Government whose principal value is adjusted periodically in accordance with the rise and fall in the inflation rate. Thus, the dividend amount payable is also impacted by variations in the inflation rate, as it is based upon the principal value of the bond. It may fluctuate up or down. Repayment at maturity is guaranteed by the US Government and may be adjusted for inflation to become the greater of the original face amount at issuance or that face amount plus an adjustment for inflation.

A bond ladder, depending on the types and amount of securities within the ladder, may not ensure adequate diversification of your investment portfolio. This potential lack of diversification may result in heightened volatility of the value of your portfolio. You must perform your own evaluation of whether a bond ladder and the securities held within it are consistent with your investment objective, risk tolerance and financial circumstances.

While the market value of a floating rate note is relatively insensitive to changes in interest rates, the income received is highly dependent upon the level of the reference rate over the life of the investment. Total return may be less than anticipated if future interest rate expectations are not met.

Diversification, and rebalancing strategies do not ensure a profit and do not protect against losses in declining markets.

Investing involves risk including loss of principal.

(0318-8V47)

Thumbs up / down votes are submitted voluntarily by readers and are not meant to suggest the future performance or suitability of any account type, product or service for any particular reader and may not be representative of the experience of other readers. When displayed, thumbs up / down vote counts represent whether people found the content helpful or not helpful and are not intended as a testimonial. Any written feedback or comments collected on this page will not be published. Charles Schwab & Co., Inc. may in its sole discretion re-set the vote count to zero, remove votes appearing to be generated by robots or scripts, or remove the modules used to collect feedback and votes.