Interest rates are rising. Year to date, the yield on the US 30-Year Treasury bond is up 24%, and from the July low, it has risen 75%. Though rates are near historical lows, they can rise quickly. When rates rise, bond prices fall, and at some point, they will threaten stocks as investors search for decent returns with less risk. Interest rates remained below 5% from 1875 to 1966 before climbing to 15% in October 1981. The 146-year average is 4.52%.
I don't anticipate rates to approach 15%, but small, upward movements can damage a bond portfolio. A 30-year bond will fall by 19.5% if rates rise 1%. The iShares 20+ Year Treasury Bond ETF (TLT) is down 5.2% this year. Rising rates are not all bad, however. Individuals with large cash balances should see their rates rise on their accounts.
How can you protect your portfolio or take advantage of rising interest rates? Here are a few suggestions.
- Deposit more money to a money market fund. The rate of interest you earn on your money market fund will increase without lowering your fund's price.
- Invest in short-term US Treasuries or CDs with maturities of six months or less. The short term duration will allow you to capture higher rates when they mature.
- Invest in a bond ladder with maturities of one year or less. A recommended bond ladder is to purchase US treasures with three-month maturities, so bonds come due at 3-, 6-, 9-, and 12- months. This ladder gives you liquidity and flexibility.
- Sell your long-term bonds with maturities of twenty to thirty years. If you own long bonds, you probably have significant gains. Sell your bonds, lock in your profits, and buy shorter-dated bonds. However, if you need the income from your bonds, don't sell. I know it's a contradiction, but one is a risk reduction strategy, the other is an income strategy.
- Buy a bond fund with a duration of one to five years. The short-term holdings in the funds will fare better than long-term securities if rates rise.
- Purchase high-quality corporate bonds. Corporate bonds offer higher rates than CDs or treasuries because they are not guaranteed.
- Invest in tax-free municipal bonds with short-term maturities. In addition to protecting your assets, you will receive tax-free income. If tax rates rise, your after-tax rate will increase. For example, a 3% taxable bond equates to a 4.76% bond for individuals in the 37% tax bracket.
- Purchase an inflation-protected bond fund. The iShares TIPS bond ETF (TIP) is up 8% over the past year.
Interest rates are to asset prices what gravity is to the apple. When there are low interest rates, there is very low gravitational pull on asset prices. ~ Warren Buffett
February 10, 2021
Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM's custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.
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