Time to pull out of bond funds? Not so fast

Most bond investors know that there is an inverse relationship between their bond investments and interest rates. When rates drop, the value of bonds tends to rise. And vice versa.

What will the Fed do next, and how should that affect your bond investments?

And as most people also know, for the past few years the Federal Reserve has kept interest rates artificially low in order to stimulate the economy. Now the Fed has begun to back off of that policy, which almost certainly means that interest rates will begin to rise.

The natural reaction to the Fed’s move is to wonder if now is the time to get out of bonds while the getting is good. While that may be an investor’s first thought, abandoning or even lowering the amount of your bond investments may not be the right move to make. Let me explain.

The roles that bonds play

Bonds historically play important roles in a portfolio.

1. Bonds generate income.

You may be using that income each month or perhaps it’s being reinvested into the fund, but regardless, it is paid if the value of the bond is going up or down. Walking away from a bond or bond fund means walking away from income.

2. Bonds can help dampen market volatility.

Stocks tend to rise higher and fall further than bonds, so holding bonds has in the past softened the ups and downs of a portfolio.

What to do today

So what should you do if you don’t necessarily want to move away from bonds, but you’re concerned that rising interest rates may affect them negatively?

Expand your bond holdings outside of the U.S.

Interest rates often are at different points in a cycle in different places in the world. While rates may be rising here at home, in some areas of the world they may be holding steady or dropping. Investing globally can help diversify an investor’s exposure to what interest rates are doing.

Remember, all investments involve risk, including loss of principal.

There’s no guarantee that an investor will achieve the results he or she is looking for. Certain conditions, such as generally rising interest rates, give good reason to review your overall portfolio. Confirm that your bond investments still fit your objective and risk levels. Then, like always, remember that investing is a long-term process that sometimes means you have to take one step back to move two steps forward.

Notes: Bond investing involves risk, which can result in the loss of principal. Bonds are subject to interest rate risk, which means the price of bonds may decrease as interest rates increase. Bonds are also subject to credit, or default, risk. Credit risk varies with bond issuers. Credit risks associated with corporate bonds are linked to the companies’ balance sheets, income statements, and earnings capacities. Any fixed income security sold prior to maturity may be subject to a substantial and taxable gain or loss. Diversification seeks to reduce the volatility of a portfolio by investing in a variety of asset classes. Neither asset allocation nor diversification guarantee against market loss or greater or more consistent returns. Corporate Bonds – There is risks associated with fixed income investments, including credit risk, interest rate risk, and prepayment and extension risk. In general, bond prices rise when interest rates fall and vice versa. This effect is usually more pronounced for longer-term securities. Non-investment-grade securities, commonly called “high-yield” or “junk” bonds, generally have more volatile prices and carry more risk to principal and income than investment grade securities. U.S. Government Bonds – Although backed by the full faith of the government, there are risks involved to include: relative yield risk, reinvestment risk, inflation risk, market risk, selection risk, timing risk, legislative risk, duration risk and call risk. This material is for general informational purposes only and should not be considered a recommendation to buy or sell any security, nor a specific investment strategy. Securities America and its representatives do not provide tax or legal advice. Readers should consult their tax advisor, or legal counsel, for advice concerning their particular situation.