This week, I’m talking about how the interest rate decisions by the Fed to raise or lower interest rates impacts your retirement portfolio.
Yesterday, I talked about how interest rate cuts impact your stock and bond portfolio. This is a timely topic because in July, the Fed cut rates for the first time in over a decade, and they’ve indicated that they intend to keep rates lower for the foreseeable future.
Today, I want to talk about a couple of costly mistakes that tend to trap investors searching for higher income in their bond portfolios when interest rates drop. There is a real danger in getting lured into searching for more income and more yield in all the wrong places.
The first place that investors usually look to increase their yield and income when interest rates drop is in longer-dated bonds. In other words, they trade in their bond that yields 2% for a bond that yields 5%. But in order to get 5% or 6% or even more, investors often need to buy bonds that mature in 20-30 years.
Here’s the problem with reaching for yield by buying bonds that mature in 20-30 years. As I talked about on Tuesday, interest rates and bond prices have a teeter-totter relationship. Interest rates go down, bond prices go up. When interest rates go up however, bond prices drop. So whenever the Fed decides to start raising rates again, those longer-dated bonds can see some pretty big drops in price, because the longer the maturity date is on a particular bond, the more sensitive it tends to be to changes in interest rates.
Investors are usually blindsided by this drop in prices which can be 10% or more depending on how much rates rise. And because those bonds don’t mature for 20-30 years, you’re stuck owning them at their lower prices, unless you want to sell and potentially take a loss on the bond.
So the lesson here is to not reach for yield and trade in your bonds for longer-dated bonds when rates drop. It’s a common temptation, but one that can lead to trouble when rates start going up again.
That’s it for today. Tomorrow, I’m going to talk about the other big mistake that investors make with their portfolios when rates drop.
Thanks for listening! My name is Ashley Micciche and this is the One Minute Retirement Tip.
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