The Federal Reserve has been talking about raising interest rates for most of this year. Given their dependence on economic data, particularly employment numbers, it appears they are about to get serious. The next Open Market Committee meeting is later this month, December 15 and 16. Generally any interest rate announcement is at the conclusion of the second day of meetings. While it’s not unheard of for the Fed to announce at different times, the Fed seems particularly sensitive to not creating surprises.
Conventional wisdom is leaning in the direction of the first raise in interest rates since the 2008 financial crisis. I believe that’s accurate, and short-term interest rates will go up .25% or so. While it doesn’t seem like much, it’s the directional pattern that matters. Many times in the past when the Fed changes the direction, they raise rates gradually over time with some degree of frequency.
According to Investor’s Business Daily, “This has been a shaky year for fixed-income investors. For many, it’s hard to imagine that the future can be any wobblier. Yet, many experts warn that volatility is here to stay and that the best strategy is to diversify intelligently and avoid taking unnecessary risks to gain extra yield.”
What does this mean for bond investors? Many people don’t understand there is an inverse relationship between interest rates and the market value of bonds. In other words, if interest rates begin going up, the market values of bonds go down to compensate for the current level of interest rates.
The other significant factor that comes to play is how far out into the future the maturities of various bonds are. Generally the farther out the maturity, the greater sensitivity a bond has to changes in interest rates. For more information on this concept, here is a U.S. News & World Report article, “A Guide to the Relationship Between Bonds and Interest Rates.”
How does this impact you as an investor? As a Financial Advisor in the industry for many years, I remember periods of rising interest rates and the devastating impact it had on bonds. It was not unheard of for some bonds to decline in current market value by 50%. Those were extraordinary times, but many advisors have little experience with a rising interest rate environment.
Now is an excellent time to review all of your fixed-income/bond investments. Chances are you have bonds in your 401 (k) and perhaps in your taxable accounts. If you don’t already have a trusted Financial Advisor, it may be a good time to reach out to a Certified Financial Planner™. Better yet, reach out to a member of the Garrett Planning Network to review your portfolios for interest rate sensitivity/risk.
There are numerous strategies available to deal with rising interest rates, some defensive and some offensive. Investor’s Business Daily has some thoughtful ideas in a recent article “Outsmart The Fed With These Dividend Investments” that is worth reading.
As they used to say in a long-ago TV series, Be Careful Out There! Call if we can help at Financial Freedom Planners.