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Interest rates are constantly changing.
But how do rising or falling interest
rates affect your investment strategies?
There is no simple answer,
of course. If you own stocks, higher
interest rates could be a cause for
concern, because when interest rates
rise, it becomes more expensive for
companies to borrow to expand their
operations. As a result, these
businesses may feel a squeeze on their
profitability and their stock prices.
And yet, some businesses are much more
affected by rising interest rates than
others, so, as an investor, you cannot
really base your actions on a blanket
statement such as: "Higher interest
rates are bad for all stocks."
The situation is a little
different if you own fixed-income
vehicles, such as bonds. When interest
rates rise, the value of your bonds will
fall. That is because no one will want
to pay you the full price for your bonds
when he or she can buy new ones issued
with a higher interest rate. To sell
yours, you have to offer them at a
discount to their face value. On the
other hand, if interest rates fall, the
value of your existing bonds will rise,
so if you were to sell them, you could
get a premium price.
Of course, if you are like
many people, you do not buy bonds just
to sell them. You want to hold them
until maturity, when you can expect to
get your principal back, assuming it is
a quality bond and the issuer does not
default. And, along the way, you have
gotten regular interest payments, which
you can use to supplement your cash flow
or to reinvest.
However, even if you do plan
on holding bonds or certificates of
deposit (CDs) until maturity, you might
want to pay some attention to what is
happening with interest rates. After
all, if you depend on bonds or CDs for
some of your income, and rates are down
when these investments mature, you could
face a difficult choice: Should you
purchase new fixed-income vehicles at
current rates, or should you park your
money somewhere and hope for rates to
rise again soon?
Fortunately, you can find a
better solution than either of these
options. How? By building a ladder of
fixed-income investments. To build a
ladder, you purchase a variety of
fixed-income vehicles [any combination
of corporate bonds, U.S.
government-sponsored enterprise (GSE)
and/or Treasury securities, municipal
bonds or certificates of deposit] with a
wide range of maturities: short-,
intermediate- and long-term.
Once you have established a
bond ladder, you are prepared for both
rising and falling interest rates. When
rates are rising, the proceeds from your
maturing bonds can be used to invest in
new ones at higher levels. When market
rates are falling, you will continue to
benefit from the higher rates offered by
your longer-term bonds.
In addition to helping you
productively reinvest your maturing bond
proceeds in all interest rate
environments, a well-structured bond
ladder may, over time, help you increase
the income you earn on your fixed-income
portfolio. And, at the very least, by
regularly reinvesting part of your
portfolio in all market conditions, you
may be able to smooth out your returns.
See your financial advisor
for help in putting together a
fixed-income ladder that can help you
meet your needs. |
