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If rates rise, what should you do with bonds?

Posted August 07, 2013 in Advice Column, Des Moines West

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.

Consequently, simply holding on to long-term bonds — especially very long-term ones, such as those that mature in 30 years — may not be the best strategy. If you review your fixed-income holdings and find that they skew strongly toward longer-term bonds, you may want to consider reducing your exposure in this area.

If you own bonds, you do need to be aware of where interest rates are — and where they may be headed. Nonetheless, as we have seen, you don’t have to be at the mercy of rate movements. By keeping yourself informed and choosing the right strategies, you can benefit from owning bonds and other fixed-income vehicles in all interest-rate environments.

This article was written by Edward Jones for use by your local Edward Jones Financial Advisor.

Information provided by Daniel Evans Jr., financial advisor, Edward Jones, 1129 42nd St., Des Moines, 515-274-9811.

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