HEATH, TX – 31 Mar, 2016 – The Federal Reserve interest rate hikes that had been anticipated for more than 12 months are now a reality. Many retirees and Baby Boomers wondered how rising interest rates would affect their retirement portfolios. In preparation for the inevitable rate hikes, many financial professionals focused on how to navigate the conservative investment landscape. At a time when any interest rate increases could translate to decreasing bond prices, bond-heavy retirement portfolios faced challenges.
Indeed these rate hikes were not good news for long-term bond investors, especially those who have not recently reevaluated their retirement portfolios before the hikes began to take effect. Anyone who chose to hang onto long-term bonds despite the impending rate hike could see the value of those bonds go down.
According to financial advisor Reid Johnson, President of Lake Point Advisory Group in Heath, Texas, there could be a problem with following the traditional rule of thumb that conservative investors should just put a higher percentage of their retirement portfolio in bonds.
“That may have been a good strategy for conservative investors in the past, because until now, bonds had been in a 30-year bull market,” he says. “This same strategy is probably not going to be in the client’s best interest today, as both long- and short-term interest rates are near all-time lows.
“Not only do we have stock market volatility to deal with, but now interest rate volatility is a major concern as well. We are in unchartered waters.”
According to Johnson, clients who are retired or just a few years away from retirement should be even more risk-averse because the potential for rate increases could mean quickly needing to shift assets into less volatile products.
In 2016, some traditional investment strategies could potentially be less viable for conservative clients who may be better off in cash or alternative fixed vehicles, such as annuities, instead.
When evaluating the fixed-income portion of their retirement portfolio, investors also need to look at the maturity dates of their bond funds. If a fund invests in longer-term bonds in the 10- to 30-year maturity range, these are especially interest rate-sensitive. Their value will drop more than short-term bond funds as interest rates increase. Investors with shorter-term bond funds could fare better because as the underlying bonds mature sooner, these funds can reinvest in newer issues with higher interest rates. Investors could then also benefit from reinvesting the increased income at higher rates.
Long-term bonds are vulnerable to more interest rate volatility than short-term bonds because over a longer period of time, the probability of interest rates rising is much higher. Short-term bonds do not carry as much volatility because interest rates are less likely to change considerably in the short term. Short-term bonds are also easier to hold until maturity, which improves the probability of getting back all of the principle.
Another factor investors should consider is that long-term bonds are often a major part of target-date funds found in many 401(k) plans. For decades many have opted to buy and hang on to these long-time favorites of their parents and grandparents. Target date funds are popular because they greatly simplify the investment decision-making process for many clients. While the long, historical track record of target funds can appeal to aging populations, many target-date funds are exposed to high levels of interest rate volatility.
As interest rates return to historically normal levels, many retired investors could potentially wait too long to reduce their interest rate volatility exposure. The Jan. 2, 2016 Fed rate hike was the first in almost 10 years, and there is a good chance that more hikes are coming.
Those hardest impact by the rate hike are investors who spent 2015 in a holding pattern over the Fed’s announcements of an impending interest rate increase. Making changes to their portfolios instead of taking a “wait-and-see” approach could have helped them avoid bond market losses. However, bonds have been comfort-zone investments for many years, and not everyone was ready for change.
“Retirees and pre-retirees had a difficult time assessing the impact that an interest rate hike would have on their long-term bonds, and many were afraid to do something different,” Johnson says. “Conservative investors need to brace themselves for more volatility than they’ve ever seen before. They could be forced to make a choice: either look for alternative methods of fixed income investing, or face the increased volatility of an uncertain bond market.
Even a small rate hike like this recent one of .25 percent can impact retirees with bond-heavy portfolios. Long-term bond owners who still plan to work for 10 or more years may have a chance of riding things out as long as the market normalizes before they retire, but current retirees may not have that option. Over the next year, and particularly if the Fed becomes more aggressive with its plans, conservative investors may need to move some of that long-term bond money into other securities to offset the price drop.
Any time the Federal Reserve raises the interest rate, it suggests the economy is improving, but for bond holders, it can mean a different story. Still, the impact of rate increases on long-term bonds remains relatively unclear. This is because the value of bonds is influenced by a variety of factors, including global growth and inflation. A rate increase may cause some investors to sell their long-term bonds, but it’s likely there are still plenty of investors who remain attracted to the long-term safety of Treasury debt, especially with the recent stress in the high-yield debt market. With concerns about the global economic outlook and how it may affect stocks, the decision is indeed complex and difficult.
For more information about us, please visit http://www.lakepointadvisorygroup.com
Company Name: Lake Point Advisory Group
Contact Person: Reid Johnson, President
Phone: (214) 771-3363
Country: United States