I have short and intermediate bond funds. What should I do to protect myself if or when interest rates rise? Should I invest in individual bonds now?
Terry Says: As I have explained many times, when interest rates rise, bond prices fall. No one wants to be stuck for a “long time” with an old, low-yielding bond. If you hold the bond to maturity — in however many years the bond is scheduled to mature –you will get your $1,000 back. But in the meantime, you’re stuck getting lower rates than you could get on newly-issued bonds (when rates start to rise). So if you sell your bond, the buyer will pay you less than the $1,000 face value to adjust for the fact they are getting a low rate.
How much less than face value? That’s determined by the market place — for all bonds, whether government, corporate, or municipal bonds. The longer the maturity, the bigger the discount from face value that the bonds will be trading at.
Of course, other things impact the price of your bond. If a company has problems, or gets its bond rating downgraded, then fewer people will want the bond. That means you will get a lower price if you want to sell.
And those are the double risks in bonds — interest rate risk and credit risk. That risk applies to individual bonds, and to fixed portfolios of bonds in funds.