On my drive into work, I heard a radio commercial from an investment expert warning investors that higher interest rates will be devastating to a bond or fixed income investor’s portfolio. Obviously, he wanted listeners to call him right away. I wanted to call and deliver a tongue lashing but restraint prevailed. I have been fighting the “fear higher interest rates” battle for years now. Looking at the data, the evidence just does not support the advertisers’ claim.
Consider the following:
Short term interest rates in the U.S. have been near zero for almost 10 years. An investor who sat in cash for the past 10 year because he was worried about rates rising earned nothing. An investor whose portfolio mirrored the returns of the overall US bond market earned approx. 52% over this same period.1 Assuming a $100,000 investment, this difference in earnings is over $50,000. Quite the opportunity cost!
There have been five periods over the last 31 years where the Federal Reserve was raising short term rates. In four of these five periods the bond market was positive. The one period returns were lower by 2.2% – hardly devastating.
Below is a chart that covers the 1951-1981 period where the 10-year treasury bond’s interest rates rose from 2.7% to over 13.7% (blue line). Also displayed are the annual returns of 10-year government bonds (green and red bars). Notice in most years, the return is positive. In fact, the largest annual loss was 5%. Devastating to me are losses of 25%, 35% or 50% not those in the single digits. Even the last five years of the chart where rates more than doubled to 13.7%, bonds still yielded mostly positive annual results.
In general, my belief is that fixed income investors should welcome higher rates. More income can be generated if rates rise. The low rate environment over the past 10 years has starved those investors seeking safer, income-based returns. One caveat is that there are many different types of bonds or fixed income investments. Not all bonds are created equal. Some types I would not want to own if I were certain rates were going to rise. However, as a whole, the next time you hear a dire warning on the bond market, ignore it.
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Jon Giordani is Chief Investment Officer for PSG. He provides innovative investment planning strategies to our clients. For questions regarding this article, Jon can be reached at firstname.lastname@example.org.