Are rising interest rates a concern? Will a rate hike affect your current investments? Are there any strategies to insulate yourself from the potential risks associated with rising rates? These are just some of the many questions that investors need to ask themselves in anticipation of rising rates. As we near this inevitable rate hike, it is imperative for investors to have a firm understanding of how rising rates can affect fixed income securities. Opportunities may exist to implement strategies which may help to insulate their investments from potential downside.
As interest rates have stagnated at historical lows for quite some time, it has become commonplace to forget that rates will rise eventually. Now that the U.S. economy has been on a steady rebound, the Federal Reserve has begun to ready our economy for a rise in interest rates. Although it has not been indicated as to exactly when rates will rise, it has been made abundantly clear that we are closer to this increase than ever before. It is critical for investors understand the impact that this rise will have on their investments and finances.
What is the relationship between interest rates and the price of fixed income securities? There is an inverse relationship between interest rates and bond prices. This means that as interest rates increase, bond prices will decrease, and vice versa. Therefore, the value of your fixed income investments could suffer declines as interest rates begin to rise. The risk associated with this inverse correlation is known as interest rate risk. Aside from Bonds, mortgages are another fixed income vehicle that may be adversely affected by a rise in rates. Those with adjustable-rate mortgages may experience a rise in payments as rates begin to ascend. Additionally, loans (consumer loans, credit cards and student loans) may begin to decelerate, as the cost of borrowing may be far more expensive.
As we approach a higher interest rate environment, it is vital to position one’s investments accordingly. The astute investor should situate their investable assets in effort to mitigate the potential adverse effects associated with interest rate risk. Be aware that as interest rates rise, bonds with longer durations (or lengths of time until maturity) are far more volatile than those bonds of shorter duration. Additionally, re-allocating your long term bonds to shorter term fixed income securities may help to combat the depreciation in bond values as rates rise. It is important to understand that there is not one strategy that will work for everyone and therefore, it is crucial to have your situation and investments reviewed by a professional.
If you would like to learn more about how rising rates affect fixed income securities, be sure to view the latest edition of the Mitlin Minute. Should you feel that your investments may be negatively impacted by rising interest rates, it is in yours and your family’s best interest to have your situation evaluated, in effort to plan accordingly. Do not hesitate to give us a call at (631) 952-4466 x12 and see how Mitlin Financial can help protect your financial future.
Disclaimer: This article represents the opinion of Mitlin Financial Inc. It should not be construed as providing investment, legal and/or tax advice.