UNION COUNTY — The Federal Reserve recently changed their stance regarding economic stimulus in this country and subsequently began to “taper” their bond buying. One of the consequences of this strategy is that it tends to push interest rates higher.
This is not very good news if you have a portfolio that is primarily invested in bonds. Bonds can provide predictable income and principal protection over time.
The problem with bonds is that rising interest rates are destructive to fixed income portfolios. When interest rates rise, bond prices fall… and sometimes the moves can be dramatic.
Consider some of the conditions that typically lead to higher rates:
• Stronger economic growth
• Rising inflation
• Growing expectations that the Federal Reserve will raise short-term rates
• Elevated risk appetites prompting investors to sell safer fixed-income investment and buy higher-risk investment
The good news is that there are investments that can be used to hedge against the potential destruction caused by rising interest rates. Consider adding the following to your fixed-income portfolio.
Floating Rate Bonds
• Floating Rate Bonds have a variable rate of interest that can pay higher yields if rates go up
• Interest rate risk is largely removed from the equation
• Short Term Bonds — Short Term Bonds can help provide safety when rates start going up because their maturities are closer and the odds of a substantial rate increase is less during a shorter period of time.
High Yield Bonds
• High-Yield Bonds may hold up well when rates are rising because they tend to pay higher yields than other bonds with similar maturities
• Convertible Bonds offer the growth potential of stocks (via the conversion option) and the income offered by bonds (via the coupon payments)
• May provide better protection against erosion of value in declining markets than in owning the underlying common stock
• May have less correlation to US markets
Consider adding some of the above investments as you strive to construct a well-diversified portfolio. Before investing in any of these options, be sure to discuss the relevant risks and rewards with your financial advisor. A number of investment strategies can be tailored to meet your individual needs.
Opinions expressed are not intended as investment advice or to predict future performance. Past Performance does not guarantee future results.
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