8 Tips for Bond Investors Watching Rising Rates

The below article was written by Casey Quinlan on January 23, 2015 and originally published on Yahoo! Finance.

Interest rates will rise. Are you prepared?

As the economy improves, the Federal Reserve gets closer to raising interest rates. As a savvy bond investor, you want to be ahead of the curve, but your investment decisions likely hinge on many factors, such as your age, appetite for risk and income. U.S. News contributors and Smarter Investor bloggers share their tips on how to rebalance your bond portfolio in preparation for rising rates.

Consider buying a bond fund.

Investors could benefit from choosing bond funds in a rising rate environment, says Michael Rittershaus, president of Smart401k. Rittershaus writes that bond funds have less reinvestment risk than individual bonds. “In other words, investors may not be able to reinvest the cash flows generated from these [individual] bonds,” he writes. Bond funds also provide increased liquidity, more buying power, diversification, reduced risk and easier monitoring. “Investors can go to websites such as Morningstar to obtain star ratings for a bond fund,” Rittershaus notes.

Understand the role of bonds in your portfolio.

One way to cool your concerns about bonds is to remember they are generally a safe investment. Bonds serve as an anchor to stabilize the more volatile equity side of a portfolio, writes U.S. News contributor Kate Stalter. “That anchor allows investors to ride out volatility in equity markets, even in extreme cases, such as the financial crisis of a few years ago. Bond investors were able to capture gains on the fixed-income side, rather than be completely exposed to the stock market meltdown,” she writes.

Keep interest rates and global market conditions in historical perspective.

Sure, interest rates were low at the end of last year, but they weren’t at historical lows. In an interview with Stalter, Andrew Horowitz, president of Horowitz & Company, a financial planning and investment management firm in Fort Lauderdale, Florida, suggests investors consider paring their holdings of U.S. Treasuries this year. “Keep a watch on the changes in the slope of the yield curve to better understand where the biggest changes are being seen,” he says.

Expand your horizons beyond the U.S.

According to a February 2014 Vanguard Group report, non-U.S. bonds are the world’s largest asset class, Stalter reports, but few U.S. investors have exposure to them. Instead of attempting to predict interest rates, investors could look outside the U.S. for opportunities. Some experts suggest allocating between 15 percent and 20 percent of a fixed-income portfolio to international bonds, Stalter reports.

Consider municipal bonds, which offer high quality at a lower price.

Municipal bonds are not as secure as Treasury bonds, [but] the rate of default on AAA/AA-rated general obligation or essential-service revenue municipal bonds has been exceedingly low,” writes Dan Solin, director of investor advocacy for the BAM Alliance and a wealth advisor with Buckingham. Muni bond investors also typically pay less in annual fees. But Solin cautions: “Even if this expense ratio is low, it does lower your returns.”

Your age is an important factor.

Matt Jehn, managing partner at Royal Oak Financial Group, says investors should also factor age into their bond portfolios. He counsels baby boomer clients to focus on shorter-duration bonds of two years or less and recommends younger investors buy longer-term bonds and invest in the stock market and emerging markets. “Someone in their 20s just needs to be diversified and ride it out,” Jehn says. “Right now, the only yield you can get is in the stock market.”

Consider shorter maturities.

Investors rebalancing their portfolios may want to consider bonds with shorter maturities, writes U.S. News contributor Lou Carlozo. In an interview Carlozo, Taylor Winn, president and founder of Atlanta-based Buckhead Wealth Management, says, “This is a good time to move out of open- and closed-end bond funds and into individual bonds with shorter maturities — eight years or fewer — in preparation for a potential inching up of interest rates in the third quarter of 2015.”

Don’t try to forecast where interest rates will go.

Investors should avoid interest-rate predictions. Instead, they should focus on bond maturities and credit quality. In an interview with Stalter, Dan Goldie, president of Dan Goldie Financial Services in Palo Alto, California, and co-author of the book, “The Investment Answer,” advises, “I don’t think [forecasting] can be done accurately enough to add any value. In my portfolios, I keep the maturities short and the credit quality high … If one does that, there’s no reason to be concerned at all about what rates do, because those securities have relatively low interest-rate sensitivity.”