Do You Know How Rising Interest Rates Can Impact the Bonds in Your 401k?
If you're like most people, you own some bonds in your 401k. And, most likely within mutual funds and or exchange traded funds (ETFs). So, it's important to know how changes in interest rates can affect your 401k.
There Is an Inverse Relationship Between Interest Rates and Bond Prices.
Recall what happens when the stock market falls in value. What happens to your 401k? If you have a generous investment in the stock market at the time, your 401k value will likely go down. Well, bond values can go down, even significantly, in a rising rate environment. Here's a primer on what can happen.
There Is an Inverse Relationship Between Interest Rates and Bond Prices.
As interest rates go up, bond prices tend to go down and vice versa. On average, interest rates have been falling over the last 30 years. This means that your bond prices have gone up! Most have enjoyed significant increases in value in their bonds within their 401k or other investment portfolios.
Bond investors have often considered bonds a safe haven for their money. But, in a rising rate environment, the risk of loss can increase. When interest rates rise, bond yields rise and the price of a bond that's already issued falls.
Owning an Individual Bond vs. A Bond Fund
With the exception of a default, if you own the individual bond and plan to hold it to its' maturity date, rate changes may not matter to you.
However, if you own bonds within a bond mutual fund and/or ETF, the underlying bonds are not ordinarily held until maturity. Most people own bonds in their 401k within a bond mutual fund or ETF. In many cases, by prospectus, these bonds are subject to things like minimum maturity rules. Also, investors in mutual funds are subject to other investors redeeming their shares. In so doing, the mutual fund manager may have to sell bonds to meet those redemptions. Losses, from a portfolio management standpoint are only useful if there are gains to be offset.
So, the Way You Own a Bond, Whether It Be an Individual Bond or a Basket of Bonds Within a Mutual Fund or Etf Matters.
And, in a rising rate environment, we believe it's important to know not only what you own but how you own it in order to better understand both the potential risks and the potential rewards.
Of course, it all depends on whether the rates that go up are short, intermediate or long-term rates. What also matters is the time until maturity, quality, and the amount of the coupon of your bonds, among other things. That's why it's important to be aware of your bond portfolio or bond funds when there's a greater chance of rates rising.
If you have specific questions, please send us an email at info@lenityfinancial.com.
Special Note:
Mark Bova of Lenity Financial is a Nationally recognized expert on Fixed Income and Exchange Traded Funds. For the latest from Mark on this subject, read more in Financial Planning Magazine. https://www.financial-planning.com/news/defined-maturity-etf-ladders-hedge-against-rising-interest-rates
Important Note:
The views expressed in this post are as of the date of the posting. These views are subject to change based on market and other conditions. This post contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance. Actual results or developments may differ materially from those projected.
Nothing in this post should be construed as an offer to sell or the solicitation of an offer to purchase. Nothing is intended to be, and should not be taken to be, investment, accounting, tax, or legal advice. If you would like investment, accounting, tax, or legal advice, you should consult with your own financial advisors, accountants, or attorneys regarding your individual circumstances and needs. No advice may be rendered by Lenity Financial, Inc., unless a client service agreement is in place.
Source:
Fortune Magazine 9/26/18, Trading Economics 10/17/18, Board of Governors of the Federal Reserve, Lenity Financial, Inc.