So far this year (2018), conservative investors have generally underperformed. How is that the case if interest rates are on the rise?


Conservative investors typically hold at least 50% of their investments in bonds, providing them with a fixed stream of income in retirement. Historically, bonds are a lower risk investment with lower volatility when compared to stocks. Their value is also less dependent on the stock market, so bonds can provide protection in down markets. However, bond prices are tied to the level of interest rates.

When interest rates rise, bond prices decline. This happens because, as interest rates go up, bonds previously sold at lower rates are no longer as valuable as those available at the new, higher rates. For example, if you could pay $1,000 for a 5% Return on Investment (ROI), why would you purchase an older bond returning only 4%? You wouldn’t, so those bonds with a 4% ROI, in this example, would lose value.

The Federal Reserve has steadily raised interest rates throughout 2018 and stated its intention to raise rates again before the end of the year, if economic conditions warrant it. The Fed uses interest rates as a lever to cool down the economy and stave off inflation. So conservative investors who own bonds that are not set to increase with interest rates are at greater risk of losing principal.

What’s a conservative investor to do in a rising interest rate environment? One strategy is shifting investments to short duration, floating rate, and interest rate-hedged bonds. Doing so may help to reduce interest rate risk. Also, incorporating some inflation protection in the current environment may also be a prudent approach, to help protect purchasing power.

With so many market variables at play, our current economic climate can be confusing. If you have any questions about this or anything else related to your portfolio, please contact us. We are here to help SimpliFi the complexities of investing.

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