Right here’s how rising rates of interest could have an effect on your bond portfolio

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Many retirees rely on bonds for income, reduced risk, and portfolio growth. However, as the Federal Reserve prepares to hike rates, some are concerned about the impact on their nest egg.

The cost of living has been rising for months, with the consumer price index, the main measure of inflation, rising 7% year on year in December, the fastest since 1982, according to the U.S. Labor Department.

Last week, Federal Reserve Chair Jerome Powell said he expected a series of rate hikes this year with reduced central bank pandemic support to quell rising inflation.

This can worry investors as market interest rates and bond prices typically move in opposite directions, meaning that higher interest rates generally cause bond values ​​to fall, known as interest rate risk.

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For example, let’s say you have a $1,000 10-year bond with a 3% coupon. If market interest rates rise to 4% in a year, the asset is still paying 3%, but the value of the bond can fall to $925.

The reason the price has fallen is that new bonds may be issued with the higher 4% coupon, making the original 3% bond less attractive unless someone can buy it at a discount.

With higher yields elsewhere, investors tend to sell their current bonds to buy the higher-yielding ones, and strong selling drives prices lower, said certified financial planner Brad Lineberger, president of Seaside Wealth Management, based in Carlsbad, California.

Why retention is important

Another fundamental concept of bond investing is duration, which measures a bond’s sensitivity to changes in interest rates. Although expressed in years, it differs from the bond’s life as it takes into account the coupon, the time to maturity and the yield paid during the life of the bond.

As a rule of thumb, the longer a bond’s duration, the more sensitive it is to interest rate increases and the more its price will fall, Lineberger said.

In general, if you’re trying to reduce interest rate risk, consider shorter-dated bonds or bond funds, said Paul Winter, a CFP and owner of Five Seasons Financial Planning in Salt Lake City.

“Also, other factors being equal, bonds with higher coupon rates and lower credit quality tend to be less sensitive to higher interest rates,” he said.

A longer timeline

While rising interest rates will cause bond values ​​to fall, the declines will ultimately be more than offset when the bonds mature and can be reinvested for higher yields, said CFP Anthony Watson, founder and president of Thrive Retirement Specialists in Dearborn, Michigan.

“Rising interest rates are good for retirees with a longer-term time frame,” he said, and so are most people in their retirement years.

The best way to manage interest rate risk is to have a diversified portfolio, including international bonds, with short to immediate maturities that are less affected by rate hikes and can be reinvested sooner, Watson said.

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