What Happens to Bonds When Interest Rates Rise?
After many years of holding the federal funds rate near zero, the Federal Open Market Committee raised its benchmark interest rate by a quarter point, to a range of 0.5 to 0.75 percent, in late 2016. This was in response to improved economic growth and low unemployment levels.1
When interest rates rise, the prices of traditional bonds generally fall, and vice versa.2 This is because existing bonds with lower coupon rates have less resale value relative to new bond issues that feature higher rates. As a general rule, for every 1 percent increase in interest rates, a bond’s price will fall by about 1 percent for every year of duration. For example, a 1 percent increase in interest rates will cause the price of bonds with a five-year duration to decline by about 5 percent.3
Duration refers to the number of years before a bond matures. The longer the duration, the more at risk the bond is to interest rate fluctuation, which is why longer-term bonds experience greater price declines when rates rise.4 In other words, should interest rates rise, the investor will generally have a lower-rate bond yield for the duration of that bond.
If interest rates drop, the investor is fortunate to continue receiving the higher-rate yield until the bond matures. Additionally, since the bond now offers a higher value relative to new bonds issued at a lower coupon rate, the investor may be able to sell the bond at a higher price than he bought it. In this scenario, the bond price will rise commensurate with its duration.5
There are a couple of things to keep in mind. First of all, because the direction of interest rates is not easy to predict, an investor may hold a selection of bonds with varying durations so that he has options to buy, sell or hold based on any interest rate environment.
And second, if an investor is satisfied with the income received from current bond holdings, he may not have a compelling reason to sell even if interest rates change. Those bonds will continue to pay out the same level of income until they mature.
Bond obligations are subject to the financial strength of the bond issuer and its ability to pay. This information is not intended to provide investment advice. Before investing, consult your financial adviser to understand the risks involved with purchasing bonds.
1Jim Tankersley. The Washington Post. Dec. 14, 2016. https://www.washingtonpost.com/news/wonk/wp/2016/12/14/federal-reserve-expected-to-announce-higher-interest-rates-today/?utm_term=.58217feb1a94. Accessed April 21, 2017.
2 BlackRock. 2017. “What Is Bond Duration and Why Does It Matter?” https://www.blackrock.com/investing/resources/education/understanding-duration. Accessed April 12, 2017.
Things to Do Before You Retire
Some people set a particular age when they want to retire. It might be more helpful to look at your financial schedule to establish a retirement date. Just because you want to retire on a certain birthday doesn’t mean you’ll be quite financially ready to do so. After all, there’s more to retirement planning than just paying off your mortgage.
Consider the following list of 16 things to do before the big day:
- Pay off all major debt obligations, including auto loans, credit card balances and the mortgage for your primary home and any vacation properties.
- Consider life insurance needs — do you need a death benefit for your spouse, or do you have enough for both of you in retirement income sources? Do you want to ensure a legacy for your children or grandchildren?
- Consider long-term care insurance — discuss your current situation and needs with a financial professional to help determine the long-term care insurance options that may be appropriate for you.
- Consider an additional source of steady and reliable income, which may mean repositioning a portion of your investment portfolio to protect those assets from market risk and create a lifelong income stream through the use of insurance products, such as annuities.
- Conduct a house check — see what major repairs may be needed at some point during retirement, such as a new roof, water heater or HVAC system. Have appliances checked out for an estimate of how long they may last.
- Do any remodeling that’s been on your mind for a while; consider keeping a spare bedroom for future live-in help.
- Get your house outfitted to accommodate your needs in the future. It may seem unnecessary now, but it’s best to make these upgrades before you’re on a fixed income. Consider adding handrails to the porch stoop, grab handles in the bathroom, rearrange kitchen cabinets so the things you use the most are the easiest to reach, replace doorknobs and faucets with lever handles that are easier to open; if your house has several stories, consider moving your bedroom to the ground floor.
- Assess how long your cars should last; consider trading in/purchasing a new one if it looks like you might be saddled with repairs on an older car.
- Put together an emergency fund to help cover costs likely to be incurred later on, from replacing the roof to buying a new car. Even pad it for financial support you may need to provide your children or grandchildren in the future.
- Work with a financial advisor to conduct a full assessment of current and future expenses to see what can be eliminated (work clothes and dry cleaning), new expenses (taking up golf) and expenses that will “trade out” as you age (travel budget for more health care spending).
- After you figure out how much your expenses could potentially change over the years, develop a budget for each phase of retirement.
- Work with a financial advisor to help coordinate Social Security benefits with your personal savings and investments withdrawal strategy. It’s important to know that financial advisors are able to provide you with information but not guidance or advice related to Social Security benefits.
- Consider downsizing now or in the future, based on lifestyle plans. For example, if you plan to travel extensively, it may be easier to maintain a condo rather than a large house. If you plan to settle in, garden and spend time at home, keeping the family house may make more sense. However, create a contingency plan for later years in case one or both spouses need assisted or full-time care.
- Even if you don’t downsize, consider making an inventory of your possessions and getting rid of clutter you don’t need and passing on unused furniture and housewares to your children.
- Work with an attorney to establish an estate transfer plan and communicate it to all family members. Review it every few years to ensure it’s still relevant and reflects your wishes.
- Complete paperwork for medical directives and powers of attorney.
This is quite a laundry list, and it’s likely that once you get started, you’ll think of other things you should do. But consider the reassurance you’ll enjoy if you get most of these things done before you retire.
Guarantees and protections provided by insurance products including annuities are backed by the financial strength and claims-paying ability of the issuing insurance carrier.