Interest rates are going to go up – question is when and how steeply? Fear mongering in the media drills one message into our heads: rising interest rates are bad news for bonds.
While the inverse relationship between bond prices and interest rates generally holds true, you are most likely safe if you’ve got an appropriate allocation to bonds and other asset classes and a time horizon to tolerate temporary volatility.
Many factors affect changes in bond prices. Changes in bond values during periods of rising interest rates have historically been mixed. While past performance cannot be counted on to repeat, other factors combine to allow bond fund values to recover following rate increases.
Not all interest rate increases have the same impact. An increase in short-term rates will not necessarily indicate the same size increase in longer-term rates (e.g. 10-year bonds).
What is important for bond fund holders to note is that the effect of a Bank of Canada overnight rate increase on a portfolio of short term maturity bonds will be different than the effect on a portfolio of bonds with longer maturities. Thus, once again, diversification is key.
Bond yields have always been difficult to predict. A Wall Street Journal survey found that in the 25 years ending in 2009, economists got the direction of yields wrong 66% of the time.
So, forgetting about what interest rates are going to do to bond yields for a moment, think about why you’re investing your money in the first place: revisit your Investment Policy Statement. What is your asset allocation and why?
If you accept that economists have a difficult time predicting the future, a good strategy is diversification. Diversification in bond holdings means you are exposed to different sectors, geographies, currencies, maturities, etc.
If you’re concerned about interest rates movements and the effect on your portfolio, please give us a call and we’ll talk about your exposure.
Heather Holden, PhD, CIM
Wealth Advisor, ScotiaMcLeod