Bonds & Interest Rates
Paying down a mortgage is a question that we get a lot,
there is no right or wrong answer and there is no pat answer for everyone, it boils
down to your intellect verses your emotions and being aggressive verses conservative.
On the topic of, “Fed Tightening”, I thought the following
short course on Bonds might be of interest…
As the stock market declined in 2000, 2001 and 2002, many investors
eventually turned to cash or bonds.
But will bonds post stellar returns over the next marker cycle?
Probably not. To understand why, we have to look at where a
bond’s return comes from.
The total return from a bond is based on two components –
the interest or coupon rate (i.e. yield) and the change in the price of the
bond. The interest rate or yield
component is self-explanatory, but the bond price is a little trickier. Bond prices move in the opposite direction of
interest rates. For example, if interest
rates decline (like in 2000, 2001 and 2002), then the price of the bond will
rise, thus increasing the total return of the bond. But the reverse is also true. If interest rates rise, then the price of the
bond will fall, thus reducing the total return of the bond.
Since the interest rate on 10-year Treasury bonds is near
4.5%, bond prices would have to rise significantly (and interest rates would
have to fall) in order for the total return on bonds to approach the returns
they achieved over the recent three year stock market decline. With rates near 40-year lows and 0% interest
as the floor, there’s not a whole lot of room left for interest rates to fall.
As the economy pulls out of its funk, it’s less likely that
interest rates will continue to fall, because the demand for money will
increase. So if interest rates stay
stable, bond prices will not rise or fall much and the return will be primarily
from the interest rate (i.e. yield).
However, if interest rates rise, (which is almost a certainty now) bond
values will fall and if liquidated before maturity, the total return will be
reduced.
Since we don’t believe anyone can consistently time the
market, we recommend a well designed asset allocation strategy that meets your
investment goals and risk tolerance.
Have a great summer and if you have questions on any other
investment or insurance matters, be sure to give us a call.
520.884.7550
jpw@financial-architects.com
2311 E. Broadway