Thursday, June 27, 2013

When interest rates rise, how severely can retiree bond portfolios be affected?

A lot of retirees are probably alarmed about the drops in the valuations of both stock and bond funds.
It’s hard to judge how much bond fund portfolios will be affected as interest rates rise, as there are many different rates.  A quickly look at the Wall Street Journal yesterday showed that many interest indices had varied by almost a factor of 2 in the past 52 weeks.  For example, Dow Jones Corporate had varied from 2.370% to 4.321% over a year (page C5 Money and Investing; it’s well to buy a paper copy once.) .
It sounds dangerous to buy bonds when interest rates are low, because a rise will be relatively more.  If a bond had been paying 1% and the prevailing rate jumped to 2%, the value of the bond would have to drop by 50% to pay the same yield.  (Take the reciprocal of the relative percentage increase – it sounds like an Algebra I test problem,)  But bonds are also affected by “duration”.  Long-term bonds are more affected by interest rate swings than short term.

It's significant that people can hold individual bonds to maturity, and bond funds often don't (although Suntrust seems to hold tax-exempt bonds for munis that way in my experience).  I've noticed that a MetLife variable annuity has lost a lot more value in the past week than most bond funds; I don't know why itself, except that one or two fund components of it did were hit unusually hard after Bernanke's remarks last week.

I found a few references explaining all this. ICI, Schwab, Fidelity, and USA Today

New link provided to me by a visitor today. (2017/4/19)

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