Bond Risk in your Portfolio?
With interest rates near historical lows, investors should be concerned about a possible rate climb and its potential impact on their fixed income investments. Rising interest rates typically cause existing bonds to lose value.
Academic research offers strong evidence that the bond market is efficient, and that bond prices and interest rates are not predictable. This uncertainty is reflected in the often-contradictory interest rate forecasts offered by economists, analysts, and other market watchers.
Even when the experts share similar views on the direction of the economy and credit markets, reality often proves them wrong. 2009’s Wall Street Journal forecasting survey offers a good example. Among fifty economic forecasters surveyed in 2009, forty-three expected the ten-year US Treasury note yield to move higher over the next year, with an average estimate of a 4.13% yield. Only two respondents predicted rates to fall below 3.00%. Five years later and ten-year bonds are still yielding below 3%, and have only crossed over it briefly during that time.
Today’s bond prices already reflect expectations for tomorrow’s business conditions and inflation, and these expectations can change quickly in response to new information. This new information is unknowable. Investors who accept market efficiency should not be surprised when the credit markets foil the experts. If prices were easy to forecast, you should find a host of fixed income managers with market-beating returns – but most of them underperform their respective benchmarks over longer time periods.
Since no one has a reliable method for determining whether interest rates will rise or fall in the near future, investors should avoid making fixed income decisions based on a forecast, media coverage, or their own hunches.
Instead, the best course of action is to determine the appropriate percentage and types of bonds in your portfolio, and re-balance to that percentage regularly.
