Why keep bonds when rates are rising?


Interest rates are widely expected to climb in 2017. And as rates rise, bond prices fall. So does it make sense to continue holding bonds or fixed-income exchange-traded funds in this environment?

Reduced risk is the primary reason. Fixed-income securities like bonds provide a safety net in the event of a stock market crash. A portfolio that is 100% exposed to equities is going to experience heavy losses if the market crumbles. Quality bonds rarely produce a negative total return in any given year, and when it does happen, the losses are usually small.

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When interest rates are rising, as we expect in 2017, short-term bonds are the best option from a risk perspective. The market price of issues with long maturities will be hit harder when rates go up. Of course, any bonds held to maturity will be redeemed at par.

One more point –predictions made early in the year don’t always translate into reality, as I know from long experience. Last year, for example, bond prices rallied strongly in mid-year when interest rates unexpectedly declined. They lost most of those gains in the fall, but bonds still ended 2016 in the black. The iShares Canadian Universe Bond Index ETF (TSX: XBB)was up 1.36% last year, and had a three-year average annual compound rate of return of 4.28%.

Courtesy Fundata Canada Inc. © 2017.Gordon Pape is one of Canada’s best-known personal finance commentators and investment experts. He is the publisher of The Internet Wealth Builder andThe Income Investor newsletters, available through his BuildingWealth.ca website. This article is not intended as personalized advice.

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