Are Bonds the next Bear Trap in your Portfolio?
Hello, I’m Angela Bender, Managing Partner of AMJ WM, and Welcome to AMJ Wealth Strategies. Today we are going to look at what really happens to your bonds value when interest rates rise.
We’ve all heard the warnings that rising interest rates are dangerous for the bond market. Today let’s look at the relationship of Bonds and Interest Rates.
A rise in interest rates can happen for many reasons the Federal Reserve controls the level of interest paid on bonds as part of its Monetary Policy Tool kit. Another factor on a bond’s yield or interest rate is the broader market and its concern with Risk. As there is more demand for bonds because of perceived risk in a market, the yield or interest it pays moves lower. Likewise, if there is a perception of less risk than there is less demand for bonds, causing yield, or interest rates to rise. So you can look at this see saw. As Demand for bonds goes up, the yield for bonds declines. But when the market determines there is less risk in other areas of the market, then demand diminishes for bonds causing yield to rise. Now if you look at this illustration I think the picture is clear. If you own a bond and you bought it when rates where at 5% but now they are only paying people 2% your bond is worth more in the market place. Someone will pay you a “premium” to get better income than the 2% bond they could go out and buy. Makes sense right? But what if you were nervous in November 13, 2012? Remember that was after the election in the US, and maybe the Stock market turmoil was too much, so you bought the US Ten Year Treasury at 1.59% Yield. Now you’d have to pay someone to take that off your hands because they could buy a freshly minted US Ten Year Treasury bond with a yield of around 2.53%. Not so good for your hard earned capital.
This begs the question, what is the historical average yield on the US 10 year anyway? Our friends at JPMorgan Funds put out this research that tells us the nominal (not inflation adjusted) yield on the 10 year treasury since 1958 to end of the 2nd quarter 2013 averages about 6.42%. Through the end of June 2013 you can see we are at 2.49%. Makes me think twice about wanting to buy more of this asset class!
We should be concerned about where interest rates are going. For while rising rates is good for your money in the bank, it means we need to adjust our fixed income strategy. Because, as the trend line on the chart below shows, if you move much above 4% on the 10 Year Bond, then much rougher water lies ahead.
Next week in our AMJ Strategy Session, I’ll discuss what Bonds are most affected and strategies that we can use to protect our hard earned capital! I hope to see you then. In the meantime if you have questions please give us a call for your Personalized Strategy Session. Here’s the number 703-466-0477. See you next time.
* The information provided for informational purposes only, and does not constitute an offer, solicitation or recommendation to sell or an offer to buy securities, investment products or investment advisory services. All information, views, opinions and estimates are subject to change or correction without notice. Nothing contained herein constitutes financial, legal, tax, or other advice. These opinions may not fit to your financial status, risk and return preferences.