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Should you be weary of bond funds in a rising interest rate environment?

Should you be weary of bond funds in a rising interest rate environment?

| March 29, 2021
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And what about individual bonds? 

Bonds are known as the reliable workhorses of any portfolio. They exist to protect principal, building a foundation that investors rely on even when everything else goes to pot. Bond funds are mutual funds that invest primarily in bonds and can be made up of bonds from many different issuers and could provide more fluctuation in return. These funds allow investors to get the benefit of bond investments but without having to research each individual issuer’s credit rating. And bond funds might pay monthly or quarterly dividends instead of the semi-annual interest from a bond. However, just like any investment, there are risks associated with bond funds that investors should be aware of.

 

What’s the risk?

Bond prices fluctuate based on different things: including changes in the issuer's credit rating and movements in interest rates.

The market price of bonds tends to decline when prevailing interest rates rise which means bonds inside a bond fund will also decline during these times. This is interest rate risk. Bond funds carry even greater interest rate risk than individual bonds because the bond fund investor is fully exposed to the possibility of falling prices. Also, depending on how the bond mutual fund is managed, the investor could lose money if management is selling off bonds (even if they don’t want to) because investors are requesting redemptions. And since you don’t own the individual bond there is no set maturity date so the value can fluctuate a great deal.

Is preserving principal and stability a priority for you? If so, an individual bond may be more appropriate than a bond fund. Even though individual bond value goes down as well in a rising interest rate environment, you will still get your principal back because you can hold the bond until maturity. This is not always the case with a bond fund. 

 

How to use bonds and bond funds?

Individual Bonds: When Interest Rates Are Rising
In a rising interest rate environment, some investors may purchase individual bonds to take advantage of the stable principal and interest received. You could employ a laddering approach where you buy bonds at different maturity dates.

Bond Funds: When Interest Rates Are Declining or not enough capital to buy individual bonds
When interest rates are on the decline then bond prices will be rising. This could be a time for you and your Financial Advisor to consider what fits within your overall portfolio.

Rather than assuming all bonds are ‘safe’ investments, you should carefully review your options and be aware of what is happening with interest rates.

  

Take action
In the face of change and loss, the worst thing to do is panic. Be weary of purchasing bond funds in a rising interest rate environment. Talk with your financial advisor about the best strategies for your portfolio based on your financial goals and position.


 Talk to one of our financial advisors about which approach works for your investment goals.


Investing in mutual funds is subject to risk and loss of principal. There is no assurance or certainty that any investment strategy will be successful in meeting its objectives. Investors should consider the investment objectives, risks and charges and expenses of the funds carefully before investing. The prospectus contains this and other information about the funds. Contact Brooke C. Goldstein at brooke@brentwoodfa.com or (424) 363-1787 to obtain a prospectus, which should be read carefully before investing or sending money



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