Interest Rates Will One Day (Maybe Soon) Head Higher

Interest Rates Will One Day (Maybe Soon) Head Higher

by Gregory Litts on Jun 17, 2015

Interests, Investments, Bond

The Fed is preparing to increase short rates from zero, as the improving economy and labor markets no longer warrant such extreme accommodation. However, many analysts believe the fed funds rate increases will be small in magnitude and at irregular intervals. The fed funds rate governs the shortest interest rates, but yields on longer maturity Treasuries are influenced by other factors, such as supply and demand, growth and inflation. Global forces may also keep the increase in longer-term rates in check, as foreign central banks battle deflationary trends with low policy rates.

Traditional financial theory portends that bond prices fall when interest rates rise. Yet, a bond's (or bond fund's) total return comprises not just price changes, but also income. This is important because, as rates rise, the income on a bond can help offset falling prices, cushioning the overall total return. Higher rates can boost interest payments from bond funds, and help buffer negative price returns. So although the price of a bond fund may drop in the immediate term due to rising rates, over time higher rates could eventually help bond fund investors. 

Every day you hold a bond fund you earn a positive coupon return. And as time passes, the cumulative coupon continues to grow - assuming you do not take distributions. RJ Capital chooses bond funds based on your time horizon and duration. Your time horizon is when you think you'll need to spend your initial investment - also know as your principal. Duration is a measure of how long it takes to recover your initial investment. Funds with shorter duration will typically be less sensitive to increases in interest rates.   

Please contact Thomas Brown at 713-568-9780 or to discuss how RJ Capital might help you prepare your portfolio for rising interest rates.