To nervous investors, R and R may not only be shorthand for rest and recreation, but also rising rates. How to, well, rest easier with that possibility is explored in a first-rate cnbc.com column by Scott Hanson. Here is a lengthy excerpt from Hanson’s informative piece:
“As the economy strengthens and the Federal Reserve pares back its bond-buying program, interest rates could very well rise. In fact, there’s no reason why the next couple of decades couldn’t be a complete reversal of what’s transpired over the previous 30 years. Given that possibility, it’s wise for investors to understand what impact this could have on their portfolios and to take steps to prepare for the worst.
“So what should investors do to protect themselves in a rising interest-rate environment? Consider these five things:
- “Analyze your current holdings. If you work with an investment advisor or broker, request an analysis of your current fixed-income portfolio. If you do things on your own, find a tool online that can help you with your analysis. Determine what types of bonds you own, the duration of those bonds and their credit ratings. Also, evaluate the types of investments you own that may act like bonds, such as preferred stocks.
- “Abandon bond index funds. In periods with higher interest rates, bond index funds—such as the ones that can be purchased in mutual funds, ETFs and many 401(k)s—can be scary places to invest. While index funds may be great for equities, in a rising interest-rate environment, professional management is more important than ever. If you own bond index funds, consider swapping them for actively managed ones.
- “Shorten the maturity of your bonds. In general, the further out the maturity date on a bond, the greater the loss when rates rise. Many investors don’t feel it’s worth the risk to own long-term bonds, given where we are in this economic cycle. Take a look at the duration and average maturity of the bonds or bond funds you currently own. If your duration is more than five to seven years out, you may want to look to a bond manager who holds shorter-maturity bonds.
- “Expand your horizon. Some fixed-income investors only want the highest-rated bonds in their portfolio and opt for longer maturities in search of yield. Rather than just stick with government bonds, consider adding fixed-income managers that incorporate alternative assets, such as convertible bonds, floating rates and non-agency mortgages. Many of these nontraditional fixed-income vehicles don’t react in the same way as traditional bonds when rates rise.
- “Reduce your exposure to bonds. Having a portfolio that is heavily weighted to bonds may not be the wisest move right now. If rates rise dramatically, your portfolio could suffer a substantial decline and could wipe out several years’ worth of interest payments. Consider paring back on your bond holdings while increasing your holdings in different asset classes, such as equities, real estate, commodities and even cash. “