When I began my career in the financial services industry, you could have opened up a savings account that paid 17% interest. I’ll leave you to figure out how old that makes me! For most of my career – until recently – interest rates have mostly fallen.
Over the past 12 months, however, we have seen a notable rise in interest rates, and we may well see this trend continue into the near future. As an investor, you need to be aware of and plan for the effects of rising rates on your portfolio.
For GICs, the implication is obvious – higher rates mean higher rates for new money invested.
When it comes to marketable fixed-income investments such as bond funds, the implications are varied. The general rule is that when interest rates rise, the price on marketable bonds will fall. Furthermore, the price on longer-term bonds will tend to fall more than on shorter-term ones.
It must be mentioned that though the market price of bonds may be falling, they are still paying their coupon interest payments. As bonds mature within a bond fund, the maturing proceeds are being reinvested at the new higher rates.
So while it is possible for a conventional bond fund to post negative returns over a short period of time, the situation will generally work itself out in the medium term.
Not all bonds will follow this “interest rate rule” to the same degree. Indeed, some have features which may reduce or even fully offset the negative effects of rising rates (ex. floating rate loans).
Since we cannot know the future with absolute certainty, the best advice is to maintain a level of diversification on the fixed income side of your portfolio that reflects your personal risk tolerance as well as your own feelings on interest rates.
Should you feel that rates will rise, suggestions for the fixed income portion of your portfolio would include, but not limited to, the following: emphasizing shorter-term bond funds, including a GIC component (for guaranteed returns), and having a degree of exposure to corporate and real return bond funds as well as funds consisting of floating rate loans.
The conclusion? “Fixed income” is not always fixed! A portfolio review with your Scrivens advisor is an excellent way to ensure that the appropriate strategies are in place. You can reach a Scrivens advisor by calling 613-236-9101 or emailing info@scrivens.ca.
