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“What is the best bond investment for rising interest rates?”

The last month has been a tough one for investors. But what has been most shocking to many is that their bond investments have declined along with the stock market due to rising interest rates. Today’s question looks into how you can allocate your bond investments to better reduce risk in your overall investment portfolio.

Today’s question is:

“What is the best bond investment for rising interest rates?”


Transcript

Since the January highs, long term bond funds are down 10 to 12%, even more than the US stock market! Why is this?

Put simply interest rates are rising. And that means that the bond that you, or your bond fund purchased a year ago at a lower interest rate is worth less money today because there are higher yielding bonds being offered now. Investors can get 3 percent bonds now, so your 2% bond is no good.

So, if you are worried about the impact of rising interest rates, you want to be invested in shorter term bonds or bond funds that invest in shorter term bonds. At Hylland Capital, we use iShares’ short term bond ETF with the ticker symbol SPTS, which invests in US treasuries that mature in 3 years or less.

A simple way to estimate how a bond or bond fund will perform under rising rates is to look at the duration of the bond or the bond fund. This can be found on the mutual fund or ETFs website. Every year of the bond or bond fund’s duration means a 1% reduction in price for every 1% rise in interest rates.  

For SPTS you will see a duration of 1.86 years currently. As a rule of thumb, that means investors can expect a 1.86% decline in the fund if interest rates rise 1%. If a bond fund has a duration of 10, then you should expect a 10% decline in the fund’s price if interest rates rise 1%.

Knowing this rule should help you keep interest rate risk in your portfolio under control.

Matt Hylland