Earlier this summer the rates on the 10 year jumped by a tremendous amount in a very short period of time. You can see that here from the fairly precipitous decline in price between May and July. As you may or may not know, bond yields move inversely with price.
Since US Treasury bonds give you the risk-free rate for any given maturity, this is a bellwether for all interest rates across the board.
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I don’t know what most people are thinking, but anyone who pays even minimal attention to financial advice should know that bond prices fall as interest rates rise, and that interest rates are so low right now that they are almost guaranteed to rise. This is not a huge concern for me since I’m still mostly in equities, but I’m approaching the age at which conventional wisdom says that my portfolio should be more heavily weighted toward bonds, and I’m not sure what I’m supposed to do, given that it seems like a terrible time to buy bonds.
I think what people generally do is move toward the short end of the yield curve with shorter dated maturities since short maturities tend to be less sensitive to fluctuations in rates. You can also look at laddered bond funds.
edit: also, and you’ll need to check this, I think high yield (so-called ‘junk bonds’) tends to be less rate sensitive as well.
While it is true that anyone that invested in risk-free assets when the economy went bad is going to lose a lot of money if they have to sell early, it is also true that they made the “flight to quality” primarily because of fear of losses in the equities market. The rate wasn’t the real rate - it was lowered because of the pressure from the equities market. In other words, these people aren’t losing any more than they would have if they had taken the bad economy hit. The ironic thing is that if they had stayed in equities they would have been in much better position.
There are 2 good points in there. One is the idea of panic selling. I knew Bernanke would flood the markets with whatever liquidity was necessary during the financial crisis so I never had any doubt that things would eventually turn around and rode the crash to the very bottom and then all the way out again. I never sold a single share and so never booked a single actual loss. But so many people believed it was the end of life as we knew it that they lost their shirts.
Worse than that, when the fed continued to engage in its quantitative easing strategy, people who had just enough understanding of monetary policy to be a danger to themselves and others propagated the notion that there would be rampant inflation on the order of the Weimar Republic and made disastrous bets. The fact that gold went up to nearly $2k per ounce is attributable largely to that fear. And sure, a lot of people, myself included, did profit from that fear but those people always understood that the bubble would eventually burst.
The other good point is the difference between actual and paper losses. In judging the efficiency of your investments you should always consider opportunity costs and that means considering paper losses as well as gains. However when it comes to fixed income, if you hold an instrument to maturity (or until it’s called if it’s callable), you can avoid booking an actual loss if rates trend against you. Technically you’ve still lost money and might want to consider taking that loss, if no reason other than for tax purposes, but especially with short maturities, you have that option.
All good points. Rates have spiked recently
but are still within their long-term trends (only just).
10-year yield approaching 200-week moving average
Not that these data will directly affect me as I’ve been mainly in equities all throughout the crisis. I do have a couple of Absolute Return funds (not Hedge Funds) which have shown, so far, consistent rises which are higher than I’d get in a traditional savings account. They allow some smoothing of an overall portfolio and more ‘safety’ compared with being all in stock market equity funds - they’re allowed to hold more in cash (and they do) than a traditional mutual fund. Different AR funds have different strategies so YMMV.
deltasigma brings up a very good point about making emotional judgement calls at the worst times - when you are the most emotional - and selling at historic lows or buying into an asset where its price is based somewhat on fear. Of course there have been times in other countries - Weimer Republic, Argentina, Zimbabwe - when these fears have been with foundation, which adds to the logic of spreading risk and diversifying.
You are correct, I think.
I know that my bond funds are down right now, and I can sort of understand that this is related to rising interest rates. But what I really don’t know is WTF I should do about it.
I kinda want to sell a bond fund to take a short-term loss to offset a short-term gain I have (Yes, I also failed to count to 365; but what is done is done). I don’t know if that is a good idea, or a bad idea, or a meh idea, and I certainly don’t have any idea what rising interest rates mean for all this.
Where would I go to buy a clue?
Personally, I don’t like to give people financial advice and I’m very suspicious of web sites and people that do. It’s impossible to predict the future let alone time financial markets, something anyone who has tried managing their own investments has learned through bitter experience at one time or another. In terms of taking tax losses however, that’s another story and something you might want to speak with an accountant about. A lot of people who already have actual, as opposed to paper capital gains, will do some end of year selling to generate losses to offset those gains.
Oh, I didn’t mean to solicit advice, but on re-reading my message I see that it reads that way.
What I really want are articles that explain (a clue) that I can actually understand. Charts that show something going up and something going down are assuming some knowledge of the basics that I don’t have. I’d like something that explains the basics.
I’m not sure what you mean. Finviz has a lot of real time charts that track the futures markets. Here is what they have for the 10 and 30 year bonds. You can look at these in increments of 5 minutes, daily and weekly to get a different perspective. These will show you the price of the bonds so as the price goes down the yield goes up and vice versa.
To understand how to calculate the price from the yield or the other way around, there are probably a lot of places you can go. I did a quick search and Investopedia seems to have a piece on it here but I didn’t really look to see how good it is. Khan academy on youtube tends to be pretty good and will probably have something too.
For more charts you can also try marketwatch here.
That’s probably the most important thing to realize. There may have been a financial crash and economic downturn, with stock price drops across the board, but that does NOT mean that all companies are struggling.
Their prices may just be lower because the market’s lower; if instead of freaking out and selling, people had held onto fundamentally sound investments, they’d be a lot better off.
I’ve always heard that investing is a long-haul game; you don’t go look at your stock values every day or even every month.
My bolding.
Join the club! We’re all traveling through life with perfect rear vision and a smeared windshield.
You could look at your own attitude to risk and decide then; if your attitude to risk is low then look at ways where you make a decision which - wherever rates go - won’t make too big an impact on the end result.
E.g. I might have a holding which I’m unsure of and sell a portion of it. If I’m in profit and sell the original amount, then I’m just gambling with my profit. Or I might sell half and keep the other half in cash until I see a good entry point. Or keep 33% on the table etc. There are infinity numbers of ways you can do this. Whatever I decide on, usually if I sleep on it I’ll make a better decision the next day/week.
Final Caveat - this is really a general anecdote of something I sometimes do if I’m really unsure and/or worried. I have no idea about your tax situation so this post may not apply to you.
Fair enough.
The OP makes me think that there is something I should know that I don’t. I’m just wondering what that something is.
The point of the OP is that as interest rates rise, the value of fixed income investments fall.
Here’s an example. Let’s say you have a bond that pays 2% and interest rates are 2%. The bond has a face value of $1000. What price will it trade at? $1000, more or less - right?
But what happens if rates jump to 4%? Well, 2% of 1000 is $20. That $20 pay out is fixed. It’s not going to change. The only thing that can change is the price the bond sells at. So what price does the bond have to sell at such that $20 provides a 4% return?
IOW, you have to solve this equation - .04x = 20
When you do that you find that x = $500. So a doubling of interest rates has caused the value of the bond to drop by half.
The proper calculation is actually a lot more complicated than that. $500 paid now gets you the same 4% interest rate, but there is a time-value-of-money factor because your $500 also gets you $1000 at bond maturity some years in the future.
So you set up a stream of payments (interest every six months) followed by one large payment in Excel. Use NPV() to calculate the current value.
Also, the longer the bond term, the more important it is to base NPV on the expected future rates, rather than focusing just on current rates. A 30-year bond doesn’t lose 50% of its value if a spike in interest rates is expected to last only 3 years.
You’re absolutely right. Bonds, especially long maturities, are payment streams so you’re looking at discounted values and internal rates of return. I should have highlighted the fact that I was giving a grossly oversimplified example. Thank you.