Bond prices move inversely to interest rates. The past few months haven’t been too good for bonds. The 10-year Treasury yield has surged from 1.68% on Jan. 31 to 2.39%. Rising rates cause bonds and bond funds to decline in value, as illustrated by the iShares Core U.S. Aggregate Bond exchange-traded fund (AGG), now down 0.34% for the year to date (according to Morningstar.
With the Federal Reserve signaling a rate increase this year, and with most economists predicting rising rates, it may seem like the answer is simply to abandon bonds and move to cash. The idea would be to sidestep the rate climb and then reinvest later when yields are higher.
There are several issues to consider when thinking about what to do with your bond fund investments.
- What will the impact be on my bond funds if rates do go up? Generally speaking, long-term bonds (loans) tend to be more greatly impacted by interest rate changes than short-term bonds. One defensive strategy would be to stick with shorter term bonds. A second idea would be to increase diversification across types of bonds and across the globe. In either case, professional managers are usually needed to accomplish this.
- If you want to lock in a rate of return without any principal risk, you could either buy a ten year treasury bond at around 2.39% and hold it until maturity or give your money to a bank for something like the 1.0% return for a guaranteed 21 month period of time.
- You could use some of the money you have in bonds to pay down your personal debt. You could use it to pay down a car loan or a mortgage, especially if these loan rates are greater than the interest rate your investment is paying.
- Will interest rates actually go up? Is the economy really heating up enough to justify raising interest rates? (1st Qtr. GDP was actually negative) I would not bet on rates jumping up very quickly.
- Lastly, before bailing on your bond investments, remember why you own them in the first place. Chances are they are part of your diversified portfolio and if you were to sell them, you need to do something prudent with the proceeds.
I wouldn’t mind if the economy actually picked up enough steam to justify increased interest rates. I would love to see the job market actually improve and more people get back to work and see family wages rise much faster then they have been. As you can see from the chart below, average family wages have actually fallen over the past several years, straight down since 2009.
Historical Real Median Household Income for the United States