What impact would
rising interest rates have on your investment portfolio? Likely not as bad as
the media might lead you to believe.
Interest rate hikes
have been widely anticipated for quite some time. In fact, according to a recent
survey of top economists that the Wall Street Journal conducted, the yield on
the 10-year Treasury was predicted to rise nearly one percentage point by the
end of 2022 to about 5.00%.
But we don’t have
to look that far into the past to find the historical inaccuracy of such
forecasts. For instance, a similar survey conducted in 2010 had economists
predicting a 4.20% 10-year Treasury yield by the end of the year, an increase
from 3.61% at the time of the forecast. In actuality, rates declined to 3.30%
at year-end.
The inaccuracy of
these forecasts is well documented. In fact, a study by North Carolina State
professors titled “Professional Forecasts of Interest Rates and Exchange Rates”
found economists predict future rates far less accurately than a random coin
flip fares as a predictor.
Clearly, we can’t
be confident exactly what interest rates will do in 2022 or 2023 – and while
predictions of rising rates will likely come true – predicting the extent to
which they rise is as difficult as predicting future stock market levels.
One key point that investors
should remember, however, is that bond yields move in the opposite direction of
prices. So while the prices might fall, higher yields can often offset that. In
addition, investors should never forget the value bonds add to a portfolio as a
diversifier to stocks – because frequently the performance of stocks and bonds
are inversely related.
Why Keeping with Bonds Might Make Sense
Depending on your
goals, generally speaking, it doesn’t seem prudent to avoid bonds entirely
during periods of expected interest rate increases.
·
First, precise forecasts of rising rates are far
from certain.
·
Second, even as interest rates rise, bonds are
still likely to be far less risky than stocks.
·
Third, rising interest rates don’t necessarily
mean declining bond values are a certainty,
Finally, bonds are a vitally important part of a diversified portfolio, and
owning uncorrelated and negatively correlated assets is critical when equities
ultimately lose their luster.
