But this dynamic pays off if you are investing for the long termsay, for a goal like funding your retirement. Is now the time to invest my retirement savings in stocks? But perhaps the most important reason to continue to hold bonds is that, rising rates or no, bonds still fulfill what for long-term investors is their most important function: They act as a bulwark against the volatility of the stock market.
In general, bonds tend to do well when stocks do poorly. Aggregate Bond Index gained 5. Of course, bonds can also go through periods where they suffer losses. So rather than avoiding bonds altogether, you should instead be thinking about how best to divvy up your portfolio between stocks and bonds.
When Rates Go Up, Do All Bonds Lose the Same Value?
Ideally, you want to own enough stocks to get the superior long-term growth that stocks have historically provided, but at the same time you want to have enough bonds to provide some stability to your portfolio and to mitigate the downsize when stocks go into one of their periodic slumps. There’s no stocks-bonds mix that’s ideal for everyone. But you can at least get a sense of what’s appropriate for you by going to this risk tolerance-asset allocation tool.
The tool will also show you how your recommended mix, as well as others more conservative and more aggressive, have performed on average in the past and in both good and bad markets. Once you’ve settled on the percentage of bonds that makes sense, you can then consider measures to protect yourself somewhat from the effects of rising interest rates.
The best way to estimate how much of a hit a bond fund may take when rates rise is by looking at the fund’s duration, which is a gauge of a bond fund’s sensitivity to changes in interest rates. For example, a total U. S bond market index fund that tracks the Bloomberg Barclays U.
Aggregate Bond Index — a good proxy for the taxable bond market overall — currently has a duration of about six years. A short-term bond index fund, by contrast, would have a duration these days of between two-and-a-half and three years, thus resulting in a price drop of, say, 2.
So by limiting yourself to bond funds with short durations or by splitting your bond stake between funds with short durations say, two to three years and ones with intermediate durations say, five to seven yearsyou can mitigate the damage somewhat should rates rise.
You can find a fund’s duration on both the Quote page and in the Portfolio tab of a fund’s Morningstar. Do I have enough savings for a secure retirement? Finally, the more you know about bonds and how they work, the more you’ll likely you’ll be able to make an informed decision about how to invest in them. So I suggest you check out this question bond quiz to see how much you know about bonds.
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But what you don’t want to do is give in to the fear and anxiety about rising rates and abandon bonds altogether. As interest rates change, so do the values of all bonds in the marketplace. If you are thinking about buying bonds, or have recently bought some, you need to be aware of the effect of rising rates on your holdings.