If Rates Rise, What Should You Do with Bonds?

Interest rates are at historic lows. But they will rise eventually. If you invest in fixed-income vehicles, such as bonds, what might higher rates mean for you?



As is almost always the case in the investment world, there’s no simple answer. First, it’s important to distinguish between short-term and long-term interest rates. The Federal Reserve is determined to keep short-term rates low until unemployment improves, but, in the meantime, longer-term rates may well rise. 



Depending on your situation, a rise in long-term rates can present both opportunity and concern.  The opportunity: Rising rates can mean greater income if you invest in newly issued bonds. The concern: If you already own longer-term bonds, and rates rise, the value of your bonds will fall. That’s because other investors won’t want to pay full price for your bonds when they can get new ones at higher rates. 



Even if the value of your long-term bonds falls, isn’t it worthwhile to hold on to them? After all, as long as your bond doesn’t default — and if the bond is considered “investment grade,” a default is unlikely — you will get a steady source of income and you’ll receive the full value of your bond back at maturity. Aren’t these valuable benefits?



They are indeed — but they may be more relevant for short-term bonds. Longer-term bonds — those of 10-year duration or longer — are more subject to inflation risk than shorter-term bonds. Of course, we’ve experienced low inflation for a number of years, bu...

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