How Do Interest Rates Affect Bonds?

TL;DR

Bond funds carry more risk than assumed, with rising interest rates and an increase in riskier corporate debt. Cash may be a safer alternative.

Transcript

Alison Southwick: The next question comes to us from Guy Over There. "If I understand the general suggestions around preparing for a goal like retirement or college, the idea is that the closer you get to needing the money, the more you should be moving it from stocks to bonds and cash. However, an article in The New York Times has scared the bejes... Read More

Key Insights

• 😮 Bond funds are riskier due to rising interest rates and an increase in riskier corporate debt.
• 🫰 The aggregate bond index is on track for one of its worst years yet, down 2.5%.
• 🥹 Bond funds may hold more lower-rated bonds, increasing their risk factor.
• 🤑 Cash is a more attractive option for investors who want to keep their money safe.
• ☠️ By seeking better rates, investors can earn over 2% on cash, making it more appealing than bond funds.
• 🙃 The risks and rewards of owning bonds should be carefully considered, especially for shorter-term goals.
• 🍉 Diversified bond funds can still be beneficial for long-term investment portfolios.

Questions & Answers

Q: Is there more risk in bond funds currently?

Yes, with rising interest rates, the bond market is riskier, as seen in the decline of the aggregate bond index. Additionally, there are concerns about the inclusion of lower-rated bonds in bond fund portfolios.

Q: Should I liquidate my bond funds to pay for college in a few years?

Liquidating bond funds close to when you need the money carries the risk of bond prices being depressed. It might be safer to consider cash as an alternative to ensure the value of your investment.

Q: Are all bond funds riskier these days?

The average bond fund has become riskier due to an increase in bonds with lower ratings. Around 50% of the bonds in the aggregate bond index are rated BBB, signaling increased risk compared to pre-Great Recession levels.

Q: What is the suggested alternative to bond funds?

Cash is recommended as a safer option, particularly for money that needs to be kept safe. Interest rates on cash can be higher than bonds, especially with the potential for immediate increases when the Federal Reserve raises rates.

Summary & Key Takeaways

• The bond market is riskier due to rising interest rates, with the aggregate bond index on track for its second worst year ever.

• There are concerns about the composition of bond funds, as more lower-rated bonds (BBB) are being included in portfolios.

• Cash is becoming a more attractive option for investors who want to keep their money safe, with the potential for higher rates.