What do the recent changes in interest rates mean for your portfolio?
Posted by Rick Miller on July 23, 2013
Interest rates have risen in the last month or so, and bond prices have fallen. My recent blog posting provides a summary about what these changes mean for your portfolio, your full balance sheet, and your financial situation.
Very briefly, you accumulate assets during your earning years to fund spending for college, retirement, and other purposes. You can think of this future spending as a series of liabilities. The present value of these liabilities is the amount of money you would need today to fund your future spending.
As interest rates rise, the present value of your future spending declines in the same way that bond prices do.
However, in many cases, you plan to do your future spending after the bonds in your portfolio mature. For example, for a 50 year old, much retirement spending will occur 15 or more years into the future. Most bond funds have a duration (something like an average maturity) of substantially less than 15 years.
Liabilities with longer durations will decline more. Bond funds with shorter durations will decline less. In many cases, taking both your portfolio and the present value of your liabilities into account, rising interest rates will actually improve your overall financial situation, even though the bond funds in your portfolio may decline.
It is true that if you knew the future path of interest rates, you could theoretically time selling and buying bonds to make yourself even better off. However, as with market timing more generally, the emphasis is on theoretically.
If you have concerns about the bonds in your portfolio, please contact us so that we can address them.