“What would be the Impact to My Portfolio If Interest Rates Rise?”
Looking back on 2013, many individual investors were quite satisfied with the returns realized in their portfolios. Performance was driven by a strong domestic equity (stock) market that ended +29.6% and a relatively strong international equity (stock) market that ended +18%(1). Portfolios with a reasonable allocation to stock were more likely to achieve stronger returns. However, hidden beneath the surface we find weakness in an area most investors consider “safe capital”. The 10-year Treasury was -13.32% for the year and the 30-year Treasury was -12.54%(1). Yields on both ended the 2013 at 3.026% and 3.964% respectively(1). Clearly, the yield (income) did not make up for the devaluation. Bond value (price) depends specifically on the yield offered. As yields rise, the value of existing bonds will fall since the yield provided may be lower than current market. Conversely, if yields fall, the value of existing bonds will rise since the yield provided is potentially greater than current market.
The reality concerning most is whether or not this is a trend that may endure for an extended period of time, ultimately challenging a portfolio’s confidence in “safe income” from bonds. Upon review of the historical yield of the 10-year Treasury, we see alarming market symmetry. From 1950-1982, Bond yields went from 2.32% to a high in January 1982 of 14.59%(1). From the high reached in 1982, we have witnessed a methodical fall in yield to 1.91% in January of 2013(1). Therefore, through the first 30-year period of this study, we watched yields rise and value fall, followed by a near equal period of time where yields fell and value rose.
Investors are understandably becoming concerned the current stability in bond yields will not last indefinitely, and we will likely see a period similar to the first half of this analysis. It is very difficult to buy what is perceived to be low-income securities with extended maturities into a future where one believes rates will logically rise. Further, most portfolios are built upon the foundation of asset allocation and diversification between stocks and bonds, predicated on the concept the capital in bonds is “safe”. That safety was more or less supported by a falling interest rate market and guaranteed (by the issuer) income.
While portfolios continue to require yield, the environment (and potentially the future) requires investors to be aware and possibly consider other strategies to realize income. Portfolios can draw upon potential appreciation (selling appreciated securities to raise cash for income) or consider alternative investments to bonds for income (dividend paying stocks). Such alternatives will introduce greater market risk to a portfolio, so a diligent risk management strategy is required.
The Sherman Sobin Wealth Management Group at Morgan Stanley believes this is a paradigm shift truly worthy of appreciation. Investors should consult closely with their financial advisors and ascertain the risk associated with their current portfolios assuming rates do rise as believed. Call the Sherman Sobin Group for insights into what may be the greatest question of the last 30 years, “What would be the impact to my portfolio if/when interest rates rise?”
Source: (1) Routers
Todd L. Sherman is a Financial Advisor with the Wealth Management division of Morgan Stanley in Mount Laurel, NJ. The information contained in this article is not a solicitation to purchase or sell investments. Any information presented is general in nature and not intended to provide individually tailored investment advice. The strategies and/or investments referenced may not be suitable for all investors as the appropriateness of a particular investment or strategy will depend on an investor's individual circumstances and objectives. Investing involves risks and there is always the potential of losing money when you invest. The views expressed herein are those of the author and may not necessarily reflect the views of Morgan Stanley Smith Barney LLC, Member SIPC, or its affiliates.
Bonds are subject to interest rate risk. When interest rates rise, bond prices fall; generally the longer a bond's maturity, the more sensitive it is to this risk.
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