What Will Happen to Bonds If Interest Rates Rise?

Rising interest rates are generally bad for bond funds. This is very important for bond investors today to understand.

Let’s use an example to explain why.

Let’s say you purchased a bond with a coupon of 6 percent at par, for $1,000. You will receive annual interest of $60 ($1,000 x 6%). You will also receive your $1,000 principal back when the bond matures. Until then, however, the value of your bond will fluctuate as interest rates move.

Assume, for example, that interest rates rise to 8 percent. That means newly issued bonds have coupons of 8 percent, and your bond, with a paltry 6 percent coupon, is less valuable. Its price declines.

On the other hand, assume that interest rates fall to 3 percent. That means newly issued bonds have coupons of 3 percent, and your bond, with a 6 percent coupon, is more valuable. Its price rises.

So the market value of a bond moves inversely to market interest rates. This doesn’t matter if you plan to hold the bond to maturity, in which case you’ll receive its face value. However, if you plan to sell it sooner, interest rates matter.

The situation is further complicated if you hold shares of a bond fund. A fund holds many individual bonds instead of a single individual bond.

When interest rates rise, shareholders get scared and tend to sell their shares. In order to pay those shareholders, the fund manager may have to sell some of the portfolio of bonds. This can hurt the value of the bond fund.

Today, interest rates are historically low in the United States, and the U.S. Federal Reserve has suggested that it will increase rates.

If you’re a bond investor, be sure you understand the risks. Bonds can play an important role in a diverse portfolio, but no investment is without risk.

Three Steps to Stretch Your Retirement Savings

It’s one of the most-asked questions of financial professionals: “If I want my nest egg to support me for the rest of my life, how much of it can I safely withdraw each year?” It’s not an easy question to answer, as it depends on so many factors. However, here are some things you can consider.

Figure out how long you might live in retirement

You can’t know for certain, of course, but you can get an idea. Consider your health and look at some online calculators. If these tools illustrate anything, it’s that you probably need your savings to support you into your early 90s, just to be on the safe side.

Come up with an anticipated withdrawal rate

Once you have an idea how many years you may be relying on your nest egg, you should think about how much money you will be spending in retirement. This is your withdrawal rate. Financial advisors have sophisticated tools to do this, but you can get an idea by looking at your expenses. Don’t forget to factor in inflation.

Allow for adjustments

Finally, understand that you will likely have to make adjustments to both your life expectancy and withdrawal rate over time. The former will change based on your health, and the latter will change based on your spending and the performance of your nest egg. A market crash, for example, can derail the best of plans.

Together, these steps will help you develop a strategy to generate the income you need for a successful retirement.