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Feature Bonds Interest Rates

Why Buy Bonds If Interest Rates Will Rise?

Starting a bond ladder creates income now and produces cash flow that can be used to reinvest when interest rates are rising.

by Hildy Richelson, Stan Richelson | May 2013

Updated on July 1, 2022

The reason investors buy bonds is to achieve a secure cash flow and to reduce their risks in the stock market. However, bond prices and interest rates are extremely reliant on one another and the relationship between the two needs to be evaluated before pursuing.

If interest rates are at a low level, some investors are concerned that after they purchase bonds, interest rates will rise, and their bonds will decline in value. We examine the validity of this concern, the bond price and interest rate relationship, certain alternatives to individual bonds, as well as our proposed solution to navigating both low and high interest rates.

You should not have to wait until the end of this article to get to our proposed solution to determining if it’s a good time to buy bonds during a low or high interest rate environment: We propose a bond ladder of individual bonds structured to take into account your financial needs and objectives. The bond ladder substitutes for staying in cash and trying to predict the direction of interest rates. A bond ladder will also enhance your appreciation of the value of cash flow and the power of compound interest.

What Happens to Bonds When Interest Rates Rise?

When interest rates rise, the prices of bonds typically fall, and vice versa. This inverse bond and interest rate relationship is sensitive to both changes in expectations as well as to overall inflation. It’s also important to remember that when demand for goods and services rise, the Federal Reserve tends to raise its federal funds target rate to slow down economic growth and prevent inflation from being too high for too long.

Additionally, it’s important to understand how different bonds perform in a rising interest rate environment. Investors are more concerned with interest rate changes in longer-dated bonds because those bonds require them to accept a fixed rate of interest for a longer period of time. Offsetting this risk are higher yields relative to shorter-term bonds.

Movement of bond prices impacts investors when they buy or sell a bond. When a bond is purchased and held to maturity, a bondholder’s return is fixed regardless of what happens with inflation. Bondholders receive all interest (coupon) payments due to them from the time of purchase, plus the face value of the bond.

The Relationship of Bond Prices and Interest Rates

Bond prices and interest rates rise and fall in relation to one another like the two ends of a seesaw. The pivot of the seesaw is the fixed rate of return, called the coupon. The interest rate, and thus the cash flow on the bonds, does not change for the life of the bond.

If you were to purchase bonds with a 5% coupon, you would always have a cash flow of 5%. If you purchased the bonds at face value, (a $10,000 bond selling for $10,000), you would always have a cash flow of $500 per year. If you decided to sell your bonds and interest rates have risen, you would be paid less than $10,000 for your bonds so the new buyer could earn the higher interest rate, let’s say of 5.05%. That buyer would still be paid $500 per year in interest and receive $10,000 when the bonds came due. In a falling interest rate environment, the bonds would now be worth more, perhaps $10,500 for an interest rate of 4.95%. The interest paid would remain the same. The buyer would still receive $10,000 at maturity.

Should I Buy Bonds When Interest Rates Are Rising?

There seems to be no shortage of advice by pundits and brokerage firms about when it is a good time to buy and when it is not a good time to buy bonds. As we update this article in 2022, the Federal Reserve is raising the federal funds rate, which boosts short-term interest rates especially. Longer-term rates are also affected, but not necessarily in the same way. No one really knows how many rate hikes over how long a period it will take to tamp down an 8% inflation rate. That does not stop the media from making dire predictions about the losses that will be inflicted on bondholders in the form of lower market values.

When someone tries to judge whether or not this is a good time to buy bonds based on their expectations for interest rates, they are engaging in market timing. Many studies have shown that market timing does not work.

Unfortunately, no one really knows how the financial markets will react to the next Federal Open Market Committee, the meeting after it and so on. Therefore, we cannot answer the question: Is this a good time to buy bonds? We personally come from a place of not knowing—we know we don’t know the direction of interest rates, and we have not found anyone with a consistent track record of predicting the direction of interest rates.

What we know with certainty is that there are always three possibilities regarding the movement of bond prices and interest rates:

  • Interest rates in the future may go up,
  • Interest rates may go down or
  • Interest rates may stay within the current range.

Bond Investing and Mark-to-Market Accounting

We believe that the mark-to-market accounting concept is clouding individual investors’ understanding of the true nature of bond investing. The concept of mark-to-market means that every day, week, month or year (or multiple times a day), the current price of a bond is compared to the price at which you bought the bond. If interest rates go up, the market value of your bonds go down and you are supposed to feel distressed about your bond investment. If interest rates go down, the market value of your bonds go up and you are supposed to feel happy and contemplate selling and taking your gain.

Although mark-to-market accounting is used by all brokerage firms, we believe that the concept is inappropriate for individual investors who are buying and holding individual bonds until their due date rather than trading their bonds. Why should gains and losses be presented when the bond coupons stay the same? Since the bond coupons do not change whether market interest rates go up or down, the cash flow from the bonds stays the same. You receive the same income stream no matter what the price of your bonds is today or tomorrow.

Mark-to-market accounting is appropriate for bond funds since the funds never come due. The bonds in the fund must be sold when they no longer meet the fund’s maturity specifications. Institutions must use mark-to-market accounting, but individual investors are not required to do so. If you use mark-to-market accounting, you will be terrified of rising interest rates. Brokerage firms like mark-to-market accounting because it encourages investors to buy and sell bonds, rather than hold individual bonds to maturity.

Beginning in January 2022, many investors began to sell their bond mutual funds due to inflation fears. This created a buying opportunity for individual investors, as the highest-quality bonds were offered for sale at lower prices when the mutual funds sold bonds to raise cash. If you owned individual bonds, your statement reflected increasing losses. If you held your position, you would continue to receive the same interest payments as you did before the price decline. Interest payments are not affected by price declines. By June 2022, the flows reversed and the market stabilized somewhat.

What If You Decide It’s Not the Best Time to Buy Bonds? A Look at the Alternatives

Let’s look at the alternatives to buying a portfolio of high-quality individual bonds.

One option is to stay in cash or cash equivalents (short-term Treasuries and insured bank products). Many are investing in these products to deal with the current uncertainties. Before December 2021, short-term interest rates were close to zero. However, it is now possible to find offerings better than 2% in two years and 3% in five years. The danger here is in concentrating your assets in short-term investments that will terminate soon and may leave you exposed to reinvesting at low interest rates.

Investors have been encouraged to invest in riskier asset classes to try to improve their returns, even if they can’t realistically afford the consequences of bad outcomes. Thus, investors have gone heavily into stocks, commodities, collectibles, junk bonds and other risky investments. Many of these investments may be inappropriate for investors who have limited resources and who are nearing retirement or are in retirement because the downside risks are too great. Even dividend-paying stocks come with an uncertain outcome since, unlike bonds, they never come due. The dividend may be cut and prices may decline.

Floating rate notes, frequently issued in times of falling or flat interest rates, are not currently available in a rising interest rate market. While you might think it advantageous to purchase them now, the issuers do not see it in their best interests.

Only the federal government is offering an opportunity for retail buyers of taxable bonds. U.S. Treasury Series I bonds sold at TreasuryDirect.gov increase in value with inflation. You can purchase only $10,000 per year with denominations as small as $50. The current yield is 9.62% until October 2022, when the interest rate will be reset. You must hold I bonds for one year. If you redeem them before five years, you lose the previous three months of interest as a penalty. The gain on I bonds is taxed as ordinary income when you redeem them. If you are in a certain tax bracket, you might not have to pay any taxes on your gains if you use the money for education.

So, if you believe that rates are too low on traditionally safe investments, the risks are too great on commodities and junk bonds and stock prices are subject to the market’s volatility, what strategy should you follow?

Bond Ladders and Interest Rates

Individual investors are not institutions. We don’t live forever. We should focus on our finite lifetime needs and goals, taking into account the risks of investments.

We recommend that you consider the benefits of a custom bond ladder. Briefly, a bond ladder of individual bonds is a strategy to have one or more bonds come due in multiple years. Thus, if you have $100,000 to invest, you might have a $10,000 bond come due in each of 10 different years beginning in 2024 and ending in 2034. This is the simplest form of a bond ladder. Alternatively, you might start your bond ladder in 2029 or later years and end in 2039 and have unequal amounts of bonds in each year.

In the strategy of the bond ladder, we find the solution to the problem of losses being generated from rising interest rates when using mark-to-market accounting. Whether interest rates are rising or falling, your bond ladder of high-quality bonds will produce a consistent cash flow that you can rely on. Every year the bonds you purchased march toward their due dates and have a shorter life span.

If your bond ladder is in place before interest rates go up, you have the upside case when rates rise. This is because as interest rates go up, you will be able to increase your cash flow by reinvesting your bond proceeds (from bonds coming due and bonds being called) and your excess interest income in higher-yielding bonds. For example, if you are getting a 2% return and interest rates rise enough over time to give you a 4% return, your cash flow over time will increase by 50%. Thus, if your bond ladder is in place, rising interest rates will not be a concern but will be your upside case.

Guidelines for Bond Laddering

Consider the following guidelines in the design of your buy-and-hold bond ladder.

First, consider whether there are certain years in which you know you will need cash. For example, if your child or grandchild will begin college in six years, you may want to have one or more bonds come due in years six, seven, eight and nine. If you plan to buy a residence in five years, buy bonds that will come due at that time. Always keep enough of a cash cushion so that you can be a buy-and-hold investor.

Second, once you have taken care of your known needs for cash, consider the shape of the yield curve. The yield curve is a chart that plots the interest rates being paid by bonds of the same credit quality but different maturities. In the chart, the interest rate is found on the vertical axis and the maturity on the horizontal axis. A current yield curve for AA-rated tax-exempt municipal bonds compared to Treasury bonds is shown below.

 

Yield Curve

 

The curves change daily depending upon a variety of factors. Generally taxable bonds yield more than tax-exempt bonds, but this is not always the case. This creates a great buying opportunity for those who are interested in tax-exempt bonds.

Third, creating a ladder of short-term bonds will protect you against further increases in interest rates in the near future. However, whatever kind of bonds you purchase for your short ladder, they will provide only a small return in today’s bond market but will not protect you in a falling interest rate scenario. Since the yield curve is currently very steep for municipal tax-exempt bonds, you will receive a lot more return for investing in longer-term bonds than very short-term bonds.

Fourth, keep in mind that every year that passes, the entire bond ladder gets one year shorter. It is wise to maintain a good ladder of maturities and call dates.

Fifth, since we cannot predict what inflation or interest rates will be like in the future, our advice is to get your bond ladder in place instead of trying to determine when the best time to buy bonds is. Waiting for the ideal time before you establish your bond ladder may result in the loss of cash flow while you are waiting if your timing is not precise. There is a cost to waiting.

Our Current Strategy for Buying Bonds in a Rising Interest Rate Environment

In the current environment (June 2022), the yield curve is very steep for tax-exempt municipal bonds, meaning that longer-term bonds may yield a great deal more than short-term bonds. In this environment, we suggest the following strategy.

Purchase bonds that are free of federal income tax for your taxable accounts.

All bonds should generally be rated at least AA by Moody’s and S&P or by at least one of these rating agencies. The bonds should fall into one of the following categories:

  • Certain state general obligation bonds generally rated at least AA,
  • Certain county and city bonds generally rated at least AA,
  • Certain essential services bonds generally rated at least AA or
  • Bonds of certain universities generally rated at least AAA.

The bonds should be purchased to form a customized bond ladder designed for your financial needs. If you have no specific needs, we recommend buying bonds with due dates ranging from five to 25 years to maturity with a minimum of six years call protection.

Your customized bond ladder of high-quality bonds will result in the following outcomes:

  • Preservation of your wealth,
  • Creation of a reliable and predictable cash flow,
  • Reduction of your federal income taxes and
  • Preservation of wealth for your heirs.

Bond Funds and Rising Interest Rates

When we speak of bonds, we do not include bond funds. There are many differences between individual bonds and bond funds. The following are a few highlights.

Bond funds are not bonds; they are quasi-equities that don’t come due. Individual bonds have a due date. A fund has to sell bonds that no longer meet its objectives and purchase new bonds at current market rates. If interest rates are falling, the bond fund must purchase new bonds at those lower rates. If interest rates are rising and there are many redemptions, the fund must sell bonds into the rising interest rate market in order to meet their redemptions. An alternative for the fund is to keep substantial sums in cash earning nothing, which also lowers the fund’s returns.

If you purchase bond funds, you are making a bet that interest rates will decline. If interest rates were to continue rising for some period of time, you are making a bet that you or the bond fund manager can time the market—turn and trade out before you lose a great deal of money. In January 2022, holders of bond mutual funds started selling their shares as the Fed waited to raise interest rates. The selling trend accelerated as investors became more concerned that inflation was out of control. As rates rose, investors purchased individual bonds to lock in the higher rates. Retail bond investors saw this as a buying opportunity. By comparison, while individual bonds may have the same market volatility as bond funds, as an individual bond approaches maturity its price will move closer to its face value and its volatility will decrease. Whatever the price, the coupon will continue to pay the fixed amount.

Although you can trade out of a bond fund more easily than individual bonds, you can hold individual bonds until their maturity and receive the bond’s face value. You will not have to trade the individual bonds to get your investment back. Trading in and out is expensive and is for professional traders. Individual investors generally find it quite difficult to make two right decisions: when to buy and when to sell. If you sell at a profit, Uncle Sam is the first one to congratulate you and take his share.

It is not possible to determine the cash flow that you will receive on a bond fund because of a number of variables: trading results, future interest rates, expense ratios, trading costs and changes in holdings. Reporting of fund returns varies from fund to fund. The U.S. Securities and Exchange Commission (SEC) 30-day yield is the only true comparable fund yield.

Many bond funds invest in lower-grade (riskier) bonds to stay competitive with other bond funds and to cover their fees and expenses. Some funds are leveraged (use borrowed money) and thus are more volatile than individual bonds. They may be benchmarked to show performance, but the benchmark may itself keep changing. Some funds also use derivatives in the hope of increasing their returns. This will also magnify their losses. In times of rapidly rising interest rates and significant redemptions, mutual funds must sell their best bonds to get the best prices.

Buying Bonds in the Current Interest-Rate Environment

Here are our recommendations for how you should proceed in the backdrop of the current interest rate environment:

  • Define your objectives and financial needs.
  • Determine your asset allocation between how much of your portfolio you wish to keep safe in a custom bond ladder and how much you will use to speculate.
  • Don’t worry about timing interest rates in the market—you probably can’t anyway.
  • Set up your custom bond ladder now to generate consistent cash flow.
  • Invest your taxable account in high-quality tax-free municipal bonds.
  • Sit back and relax knowing if interest rates go up after you establish your bond ladder, that is your upside investment case.

A final and important note for investors in a high tax bracket: The yield to maturity on a long-term high-quality tax-exempt municipal bond in June 2022 is now 4.00% (e.g., Triple-A Oklahoma Housing bonds maturing in 2041 sold at face value). The tax-free equivalent return for a 4.00% yield to maturity for taxpayers in various tax brackets is displayed in Table 1. These may be attractive returns for high-quality investments if predictions of the so-called “new normal” turn out to be accurate.

tax-equivalent yield

This article was originally published in the May 2013 AAII Journal. Click here for a PDF of the original article. 

Discussion

Walt B from FL posted over 13 years ago:

This article advises using individual bonds vs bond funds. You can find a publication ("A topic of interest: Bonds or Bond Funds") on the Vanguard web site that recommends the opposite. Vanguard focuses on increased liquidity,lower transaction costs (bid-ask, wholesale vs retail) and the diversification advantages of funds. They also recognize the control advantages from individual bonds. It sure would be nice to see some real numerical analysis. Individual bonds are an asset class as are bond funds. When calculating the efficient frontier, you can use either. What's the difference in expected return for a simple asset allocation, viz., 60:40 stock index: bond using the two different bond asset classes?


Howard... from Oregon. posted over 13 years ago:

I hold Oregon mutual's, in an state fund that has a fairly long duration, but covers all taxes (Oregon tops at 9.3%) The price has increased, as well as the return. My other major holding is in the Vanguard Hi Yield bond fund. The asset value of this fund has increased nicely, and the return, in an IRA account, defers the taxation. OK, I am sitting on a time bomb when rates move up. I still recall the hit I took in the 90's sitting on bond funds! However as long as Uncle Ben continues the current policy game I feel ok. When I see a change afoot, I will go to cash. This is easy to do with these funds.


Lee from MD posted over 13 years ago:

Planning on holding a ladder of longer term bonds to maturity in our old age (say 85 plus) may not work so well providing income while we are alive. I would appreciate an analysis proving feasibility of this situation or a caution against using such a ladder should be added. Over which age groups does the article's recommendations apply?


David from Vermont posted over 13 years ago:

As Walt B says, it would be nice to see some numerical analysis - what does happen to a bond fund, in absolute terms, with rising interest rates and redeposited interest dividends? How does that compare to a bond ladder? And does a bond fund merely make immediate the lost interest that is hidden in a ladder? Which in dollar terms returns the more over years of up or down markets? Thank you.


skibutch. from California posted over 13 years ago:

I thought this was a very informative article. When you buy a bond, your principal is protected from market fluctuation. I find this comforting in the current environment. However, it is important to remember that even with the principal protection, you can loose a lot of valu to inflation.


MP from NY posted over 13 years ago:

If for all those years the High yield bond funds were doing good, if we were to take a hit when interest rates go up, I believe we are still better off then keeping it in cash or low yielding bonds(in tax deferred account). If we are long term investors, I don't see a problem with a quality High Yield Bond Fund.


Jay from California posted over 13 years ago:

Walt - Where is that Vanguard article on their site? I couldn't find it.


Jay from California posted over 13 years ago:

What I don't understand about this article is that it is suggesting laddering your bonds with due dates from 15 to 23 years, while elsewhere in the article it talks about time frames of five to ten years. I don't want to lock up my money for a minimum of 15 years when interest rates may be going up in the next few years - I will want to cash out then and invest in higher-yield bonds. Also I am within about 12 years of retirement age. It would seem to make sense to invest in bonds with a maturity of from 2 to maybe 5 years, no?


Samuel Dollyhigh from SC posted over 13 years ago:

I agree with Jay. I was surprised to read 15 - 23 years as a recommendation. As the article states - shortening up on duration would protect against rising rates. I don't know why you wouldn't want to do this in the current environment. To me the bond ladder should start somewhere between 2 and 5 years and then extend from there to longer duration bonds.


hildy from Pennsylvania posted over 13 years ago:

We recommend bonds in the 15 to 23 year range because that is where the yield is. That is the same reason Willy Sutton gave when he asked why he robbed banks. "That is where the money is." he replied. If the Fed starts to raise short-term interest rates, then our recommendation would probably change. However, if you want some yield 2 to 5 year maturities just doesn't do it! 5-year Treasuries are currently paying 0.83% taxable, while double-A rated munis are paying 0.99%. 20 year munis with the same rating are paying better than 3% currently, federal, state and maybe local tax-free.


SJ from NY posted over 13 years ago:

Buying individual bonds seems to be the way to go, but there is enough literature out there that says that it is not for the retail investor. Unlike stocks, the bond market is not very liquid and that one could get squashed by the bid-ask spread. Few articles seem to address this issue. Of course, if one directly buys from the Treasury, one avoids this problem, but for corporates and municipals one has deal with the spread. I have also noticed the lack of articles, even in the AAII, about how to intelligently go about buying bonds.


Hildy from PA posted over 13 years ago:

The problem with high yield bond funds is that there has been such demand for yield that the spreads between the high yield bonds and investment grade bonds have narrowed. You can expect the spreads to widen as interest rates on higher quality bonds improve and more pressure is put on the strained resources of the issuers of those high yield bonds. For a bond investor, rising interest rates are the upside case if you can reinvest the interest payments into higher yielding bonds. It is like income averaging up for stock investors. SJ Please read about buying individual bonds in our book: BONDS: The Unbeaten Path to Secure Investment Growth, 2011 - second edition. Thank you for your remarks, David. Lee, losses are not hidden in the ladder because the bonds ultimately come due at face value. The bond funds never come due. This is why bond funds use the concept of modified duration, which is the amount of time it takes to get interest and principal back. Each year implies a 1% change in the price when or if interest rates go up or down 100 basis points. Thank you for your comments.


Ian from Pa posted over 13 years ago:

This was a very interesting article. I also think that an alternative ladder could be built with some of the new defined maturity ETFs currently offered by iShares and Guggenheim. I wonder if anyone else has any thoughts or experience with these.


Charles Rotblut from IL posted over 13 years ago:

Hi Ian, I'm starting to look into defined maturity funds for a future AAII Journal article. -Charles Rotblut


Bernie Tarango from CA posted over 13 years ago:

This is a very one sided article.... there is no mention of transaction costs ( especially with the low amount 100K of investment). Also, there is also the risk of loss ( even with high quality) that are not factored. Very disappointed in the analysis and presentation of facts.....


Harry from PA posted over 13 years ago:

A couple of quick points. Willie Sutton never said that, but did use it for the title of a book. If you can't find an article at a web site, for ex. Vanguard, use Google. Google's search is better at finding articles anywhere on the web than VG's search is for just its own web site. For me the argument that a bond doesn't lose value but a bond mutual fund does is equivalent to sticking your head in the sand. If a I bought a bond yesterday and put it in my safe deposit box, it's easy to ignore the fact that I just "lost" money today because rates went up. But if you don't sell then you don't lose anything either way.


James Pier from OH posted over 13 years ago:

There's a reason Warren Buffett's asset allocation advice is a whole lot different than 100% bonds. 1. The Richelsons' advice is clearly biased, and AAII owes it to its membership to publish that caveat. If one's entire advisory business is built on advising investors to invest in bonds, not to mention selling books with that advice, then one is not about to come out and say that bonds are the wrong place to be, or even relatively high risk in the current environment. 2. The long-term average returns for stocks and bonds and other asset classes are interesting, but certainly not dispositive in making decisions. One must consider each alternative at the then available market price. Buying high, even if one doesn't intend to sell low, can only lead to lower-than-average returns over time. As the authors rightly point out, one difference between bonds and stocks is that bond prices tell you right up front what the held-to-maturity return will be. Bonds are currently so close to their ALL-TIME highs as to make their purchase at least very questionable. Find a long-term chart of bond prices and see for yourself--buying now looks crazy. In hindsight, buying stocks in late 1999 was a bad idea, but it sure was easy to feel smart doing it then. It makes no difference that "nobody knows when rates will go up." The fact is that yields are very low--inadequate to build wealth and dangerous vis a vis maintaining wealth while drawing income. Unless one is already quite wealthy, 100% bonds is as sure a loser as one can find among the various asset classes. It is not a question of whether bond prices will fall, only when, how much, and how fast. 3. What difference does it really make if I ladder my portfolio? Suppose I hold 10 bond positions of laddered maturity, and one of them comes due during a higher-rate environment. I can reinvest 10% of my portfolio at a higher rate. Oh good. The other 90% I hold at a loss, whether I want to sell them or not, and I continue to suffer with their dismal yields. Building a bond ladder of 15-23 year duration today means locking in low returns on most of your portfolio for an awfully long time.


Hildy Richelson from PA posted over 13 years ago:

Dear Mr. Pier, We cannot foresee the future and therefore cannot advise our clients to try one investing alternative rather than another based on prospective outcomes. What we suggest is a low cost strategy that has fairly predictable outcomes. We do not say that it is perfect, nor do we say that this is the solution for every investor. For high net worth individuals, and investors who follow the credo "Slow and steady wins the race," investing in high quality individual bonds creates a predictable stream of income. As interest rates rise, they can reinvest the income into higher yielding bonds. I don't know about you, but I prefer to reinvest at higher interest rates. Waiting until they rise has its own costs, as many investors found. They created five year, short-term bond ladders yielding nothing because they knew that interest rates would soon rise. They lost the opportunity to have the interest payments compound - the basis of growth in bond investing. Stock market investors required extraordinary staying power to wait more than ten years until stock prices picked up. Long term stock investors saw volatility for many years, but it was not until 2012 that the stock market finally rose above the March of 2000 high. There is no perfect advice for anyone. Each of us has to weigh the information and then chose the best path. Investing in high quality bonds provides greater predictability, and some investors may chose that despite the downsides.


Stephen Sanders from NY posted over 11 years ago:

Very biased article on buying individual bonds---AAII should state a disclaimer..... I am in all funds---have been for years----doing very well....


Hildy Richelson from PA posted over 9 years ago:

I am very happy for those who are doing well. Mutual funds and ETFs are bets that the markets are favorably rising. Both bond and stock market have been doing just that. Every investment style has advantages and disadvantages. I would much rather see someone with limited understanding and experience invest in a fund than an individual security because they get more diversification and are therefore better protected. However, there is a real place for investing in high quality individual bonds. Individual bonds are the only investment where the bonds come due. You do not need someone else to buy your position to exit the investment. They pay steady and reliable interest. For those who have an interest, please look me up.


TERRY from TX posted over 9 years ago:

I wish to thank everyone for their experience and thoughts mostly for the first. Let us "know" as the yield goes up the prices goes down. The best is when bond prices are low and yield later (real soon) goes high, "when" it cannot do anything different even if it is a company bond. This only counts if we can sell anytime that happens. Good luck with that. You sell what people globally need and other countries need money and sell first our bonds instead of using it as a safe haven as before. It is your choice I prefer to be safer. Not sure how. You can get both first from bad companies and ""sometimes' from those who do not want to fall into that group, but no one I know based on fundamentals and growth because of cooked accounting does cannot change garbage in from being garbage out. We need to live a fantasy that we control behind the curtain legally. Bonds of all kinds are good a small percentage of time now; if they follow 2 principals buy low sell high and have a buyer who can do the same. 99 % of all corporations are in debt think stock buyouts and insider selling at an all time high, think bankruptcy with laws changing for banks in trouble and not you. Your choice there may be 6 companies to win and at the right time not now I guess for gov or banks thinks pawn shops and rental centers!


Samir Desai from TX posted over 9 years ago:

This article is from 2013. AAII should not recirculate out-of-date articles. As someone else pointed out, this an extremely biased and dangerous article. It also shows the ignorance of authors with regards to the convex nature of the yield curve, and its consequences on duration. Duration of a bond is the value of a tangent at each YTM (yield-to-maturity) point on the yield curve. When the rates turn up, BONDS OF ALL DURATION LOSE VALUE. LADDERING SIMPLY MEANS "short duration bonds lose less when compared with longer duration bonds for the same credit risk." How much less depends on the steepness of the yield curve. This is an immutable fact, not open for questioning. So far, bond investors have greatly profited not just in interest, but also in capital gains. The time period between 8/1/15 and 7/31/16 has been extremely abnormal in the sense that so called "risk free" investments such as the US Treasuries have greatly outperformed risky investments such as equities. Modern Portfolio Theory tells me that such abnormality must reverse. Equity investors must be compensated for the risk they took OR the treasury investors must suffer great losses. Authors should have clearly pointed the great risks in all bonds if the rates were to rise.


James Harless from TN posted over 9 years ago:

well, with an article opposed to bond funds at this time, it follows that this view is in opposition to target date vanguard and other such target date funds that use bond funds, not individual bonds, to fill out the need for downside market protection, with some limited percent in stock mutual funds and most in bond funds held by Vanguard or others. So this logic seems to imply increased risk to target date funds , since the rise in interest rates is so slow it will likely be long term up like it has remained long term down on interest rates, so there goes some value added that once did exist for target date funds, like Vanguards funds. They are offered and held by many in my employer sponsored 401K, in my retirement. Change from target date fund to what, most folks who own target date do not wish to own or do not have experience to buy bond ladders or individual bonds, and those are less liquid than the funds appears to be another down side.


Bryan Martz from OH posted over 9 years ago:

Most of my money is in Vanguard and agree with most of their advice. However, we are now at 35 year bull market of fixed income prices (i.e., declining interest rates). My fixed income allocation is to smooth out the crazy declines in my equity allocation, e.g. 2008, so I can sleep at night. Think insurance. I no longer, after 35 years of investing, and also teach investing, use any bond funds. In my IRA, I only use new issue federally insured bank CD's , laddered, for my fixed income allocation. NO one knows when and how interest rates will move, but the odds are increasing the direction is up. If you are in Vanguard Total Bond Fund, you will be ok IF rates go up very slowly. My current technique, not only covers all future outcomes of rate moves, but also gives you federal backed insurance on all fixed income which the bond fund can only partially do if you have large sum of $. My technique gives full protection for each CD , per individual, per bank, up to $250,000 each.


Rick from CO posted over 6 years ago:

Really need to update this article, publishing a 6 year old article, that is not really relevant to today's interest rate world...rates are declining during 2H 2019. I am sure 99% of the readers can figure out which way interest rates are heading. A much more useful article, without all the political bs and injection of personal opinions, that explains impact of rising interest rates, and declining interest rates, and how to plan for these scenarios, would be much more useful.


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