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Matthew Diczok, head of Fixed Income Strategy at Merrill Lynch Wealth Management, explains why bonds will always play an important role in your portfolio—whatever direction interest rates are moving in. Watch our video to learn more.
Rising interest rates can push down the price of existing bonds, which in turn could directly affect the current value of your bond holdings. As Diczok notes, this doesn’t make bonds (also referred to as fixed income) any less essential to a well-diversified portfolio—especially as volatility or a market drop can have an impact on the value of your stocks.
If you own individual bonds, you can count on recouping the full principal value at maturity (unless the bond issuer defaults), and with many bonds, you’ll receive regular interest payments for as long as you own them.
If you invest in a bond mutual fund, you’ll also receive regular interest payments for as long as you own your shares. And because many bond funds are actively managed, during times when rates are rising, you could see your interest payments rise as well, as the manager of your fund reinvests the coupon and principal payments in newer bonds with higher yields. However, unlike individual bonds, bonds funds don’t have a specific maturity date. Thus if you decide to sell your shares, you may receive a lower or higher price than what you originally paid for them.
When investing in individual bonds, Diczok suggests you consider the four points below in building a bond portfolio. Also, think about how the bonds you choose—including the level of risk they present and their time to maturity—could help you pursue your various goals; whether you’re saving for a down payment on a new home, a child’s college education or your own retirement. Be sure to reach out to your financial advisor when making any investment decisions.
For more on this topic, read our article Stocks or Bonds: What Happens When Rates Rise?
Investing involves risk including the possible loss of principal investment.
Investing in fixed income securities may involve certain risks, including the credit quality of individual issuers, possible prepayments, market or economic developments and yields and share price fluctuations due to changes in interest rates. When interest rates go up, bond prices typically drop, and vice versa.
Investments in high-yield bonds (sometimes referred to as “junk bonds”) offer the potential for high current income and attractive total return, but involve certain risks. Changes in economic conditions or other circumstances may adversely affect a junk bond issuer’s ability to make principal and interest payments.
Income from investing in municipal bonds is generally exempt from Federal and state taxes for residents of the issuing state. While the interest income is tax-exempt, any capital gains distributed are taxable to the investor. Income for some investors may be subject to the Federal alternative minimum tax (AMT).
Investments focused in a certain industry may pose additional risks due to lack of diversification, industry volatility, economic turmoil, susceptibility to economic, political or regulatory risks, and other sector concentration risks.