Short Term Bonds Work When Interest Rates Rise

If you want to stay in the fixed-income market but are afraid that interest rates might rise, you might want to consider a short-term bond fund. You’re still invested in an income fund, but the shorter maturities of the bonds in the fund’s can potentially protect against losses when interest rates rise.

Rates rise – value declines

Why do bond funds lose value when interest rates rise? Suppose a fund holds a $20,000 bond that pays 4 percent interest per year. Then the U.S. Federal Reserve Board (Fed) raises interest rates, and bonds start paying 5 percent interest per year.

When this happens, the market price of the 4 percent bond in the fund will decline, because no one wants to pay $10,000 for a bond with a 4 percent yield when a bond with the same value purchased now is yielding 5 percent.

Protect against rising rates

This is always the case: When interest rates rise, the market prices of existing bonds fall. (The opposite is true when interest rates fall: Bond prices rise.) But, you can help protect your bond fund against a rise in interest rates by switching to a fund that has a portfolio of bonds with shorter maturities – a short-term bond fund. With such a fund, you won’t be locked into a bond that doesn’t mature for years. The fund will contain faster-maturing bonds, which can be replaced as they mature.

Rate sensitivity measured by duration

Your advisor can help you determine how sensitive your current bond fund is to interest rates, but one way to do so yourself is to look at the fund’s average duration. Duration measures the sensitivity of a fixed-income investment’s price to a change in interest rates.

It is expressed as a number of years. In general, the longer the duration, the more a bond’s price will fluctuate when interest rates rise or fall.

Should You Wait Until 70 to Take Social Security?

Most Americans consider 65 the traditional age to take Social Security benefits, but there are other options. You can take them early, at age 62, or late, up to age 70.

If you start collecting Social Security benefits in the first year of eligibility – at 62 – you’ll receive a smaller monthly payment, but you could, theoretically, receive benefits for a longer period of time and maximize your total gain.

On the other hand, you could wait until age 70 to start collecting Social Security benefits, at which time you could qualify for the maximum possible payment.

There are pros and cons to taking Social Security early, late, or on time, but here we’ll discuss the argument for waiting. The main reason to delay taking benefits until you reach age 70 is that you’ll receive an additional 8 percent of income per year for every year past your full retirement age; this depends on the year in which you were born, but it is currently 66 or 67.

As well, your annual cost-of-living increase will be based on this higher amount, which is a significant return in today’s market environment.

Of course, in this case, you’ll need another source of income until you’re 70, which means you’ll either have to keep working or live off other investments. There also may be some concern that Social Security won’t be around if you wait the additional five years.

This option isn’t for everyone, but if you can plan ahead, it might be a compelling alternative.