Many Investors Don’t Understand How Rising Rates Kill Bonds

ETF Trends

Everyone seems to be obsessed with risks in the stock market and a potential correction after such a strong run so far in 2013.

However, many investors are unaware of the grave risks that rising interest rates pose to their bond portfolios.

In fact, a survey released Tuesday suggests most investors don’t even realize they’ve already been hurt by the spike in Treasury yields.

According to a survey by Edward Jones, 63% of Americans don’t know how rising interest rates will impact investment portfolios such as 401(k)s, IRAs and other savings platforms.

“In fact, a full 24% say they feel completely in the dark about the potential effects,” Edward Jones said.

The recent rise in interest rates has hurt fixed-income ETFs, especially funds tracking Treasuries with longer durations.

For example, iShares 20+ Year Treasury ETF (TLT) has fallen nearly 30% from its July 2012 all-time high.

“Bond prices typically move inversely to interest rates. This means that as interest rates rise, the price, or value, of bonds will decrease. Higher interest rates mean higher current income for an investor purchasing new bonds,” Edward Jones explained.

“For investors who already own a significant amount of fixed income, rising rates and corresponding falling bond values may mean lower overall portfolio value. Shorter-term bonds, while offering lower income opportunities, are less impacted by the drop in bond value seen in longer-term investments,” the firm added.

The survey is a wakeup call because many Americans have piled into bonds after getting burned twice by stocks in the dot-com meltdown and the 2008 financial crisis. Also, aging Baby Boomers are gravitating to the income and perceived safety of bonds.

One-third of respondents in the Edward Jones poll between the ages of 18 and 34 replied they have “no idea” how interest rate changes will impact a portfolio. One-quarter of those 65 and older also indicated they had “no idea.”

iShares 20+ Year Treasury ETF

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Full disclosure: Tom Lydon’s clients own TLT.

The opinions and forecasts expressed herein are solely those of John Spence, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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