UNDERSTANDING BOND MARKETS
It is CRITICAL to understand what is going on with the bond markets at this point in time. With the Federal Reserve pointing to raising rates 2 or 3 more times this year, it is important to understand what that would do to a passively managed bond fund. If you have friends who believe in a buy and hold strategy and they are conservative or retired (and therefor have the majority of their assets protected in bonds), now would be a great time to help them by sharing this information with them.
Particularly with a Treasury Portfolio or bond fund, as interest rates (yield) rise, this can cause a portfolio to decrease in value. It is nice to get a pay raise in cash flow, but at what cost?
Here is an example of how a 1% or more rise in interest rates affects a bond portfolio.
$1,000 10-Year Note at 2%
If yield rises to 3%, price drops to $914.70 (bond value may fall 9%)
If yield rises to 4%, price drops to $837.78 (bond value may fall 16%)
If yield rises to 5%, price drops to $768.35 (bond value may fall 23%)
$1,000 30- Year Bond at 3%
If yield rises to 4%, price drops to $827.08 (bond value may fall 17%)
If yield rises to 5%, price drops to $692.55 (bond value may fall 31%)
If yield rises to 6%, price drops to $587.06 (bond value may fall 41%)
Source: Rising Interest Rates
Nobody should be willing to accept this risk given the proposed Fed rate hikes for 2018. We have absolutely no idea if the Federal Reserve will follow through with their plan, speed it up or slow it down. However, the fact that their intent is to raise rates, one must look in the mirror and ask ones self; Do I want to take this much risk in my fixed income portion of my portfolio?