Increasing rates, decreasing bond prices, and concern…
Source: Securities and Exchange Commission, Office of Investor Education and Advocacy
When it comes to investing and the media, the stock market usually dominates the conversation. These days, however, the bond market and rising interest rates are increasingly in the news causing investors to wonder if they should be concerned. It can be alarming to hear commentators discuss falling bond prices. After all, bonds are typically considered the “safer” portion of a portfolio, and “falling” does not equal “safety” for most investors! And, because there is rarely any context provided to explain the relationship between interest rates and bonds, it is difficult to know if concern is warranted.
The key thing to know is that all bonds, especially bonds with a fixed interest rate, are subject to interest rate risk. That risk results in falling prices for existing bonds as interest rates increase, as show in the above graphic.
Think about it this way. Let’s say you own a bond paying 3% interest. Due to recent increases in interest rates, new bonds with similar terms are now offering 4% interest. The value of your existing bond will decrease in value because investors will want a discount to purchase a bond paying 3%, when they could purchase a new bond paying 4%.
What about the bond investments you own?
What does this mean for the bonds you own, either as individual investments or through a mutual fund or exchange traded fund? It likely means that you have seen the value of your bond investments fall, and while that can be unsettling, it is not unexpected. Remind yourself why you allocated a portion of your portfolio to bonds in the first place and review the types of bonds you hold. If your situation has not changed and your bond investments continue to be appropriate, don’t let increasing interest rates be the only factor you consider when evaluating your investment mix.
Looking for more information? This investor bulletin from the Securities and Exchange Commission’s Office of Investor Education and Advocacy offers a concise explanation and easy-to-understand examples.