New World… Of Higher Bond Yields

Calling it a “New World” is a bit of an exaggeration but since this week the yield on the 10-year US government bond topped 3% for the first time in four years, it was kind of a big deal in the investing world.

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The 10-year US government bond is a benchmark and indicator for a number of things including: mortgages, companies borrowing to grow, the price of oil … and, yes, stock prices. We all know that the “financial crisis” is now 10 years in the past and for the past 10 years interest rates have been super LOW. This has been both positive and negative for investors.

Positives:

  • Low interest rates on bonds and CDs have encouraged investors to buy, buy, buy stocks. The past 10 years have seen almost unprecedented gains in global stocks. That has been GREAT!
  • Borrowers (people and companies) have enjoyed really, really, low interest rates in buying homes and growing businesses.
  • Bond PRICES have remained relatively high, because bond PRICES move opposite to INTEREST RATES (low rates= higher bond prices; increasing rates= declining bond prices).

Negatives:

  • Investors desiring “steady” investments like bonds and CDs to “anchor” their portfolios with respectable interest income have lacked ways to generate decent income.
  • Pensions which “count on” a certain interest rate for their short- and long-term bond holdings to fund long-term pension obligations have suffered, and there have been and will be intermediate- to long-term implications for pensioners, the extent of which remains to be seen.
  • The longer the (“unnatural”) near-zero interest rate environment has lasted, the longer the consequences of “normalizing” interest rates have been delayed.

In a “new world” – new relative to the past 10 years – of rising US interest rates, driven by the US Federal Reserve AND a potentially steadily growing US economy, there will be important implications for investors of all ages. Even if bond yields rise slowly and over time investors will need to ask for professional investment advice to get an awareness of how… not to freak out.

Younger investors may have their first (or second) experience with BIG VOLATILITY in the stock markets. The fear and emotions of an intermediate-term down market cannot be understated. “Intermediate” can mean 1-3 years. Most investors freak out after one down monthHere is where the experience and education of a trusted adviser can prevent damaging mistakes.

More seasoned investors and those enjoying retirement – or those about to retire – need to understand that the perceived safety of bonds depends on what kind of bonds you own and what maturities are in your portfolio. Longer-term bonds can lose their principal value pretty quickly in a rising interest rate environment (if not already).

No matter your age, as this whole rising interest rates process unfolds – as it has over history – stocks will react from time to time on the downside because higher interest rates on bonds compete with dividend yields on “riskier” assets like stocks. “Risky” is a relative term when you are trying to keep up with inflation over your lifetime of 20, 30, 50+ years.

You may have heard me say this before, but this advice never gets old: having an investment PLAN and a set asset allocation is more important than ever. The kind of PLAN I am talking about is a written, well-advised plan alongside an adviser who is a sounding board to keep you and your portfolio on track amidst the inevitable ups and downs in the new and not-so-new world of rising interest rates.

 

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