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Many investors are concerned about higher interest rates. Bond investors know that when rates rise, bond prices fall, and stock investors are concerned that rising rates will undermine the bull market for stocks.
Of course, no one knows when or how rates might rise. Some believe that rates will rise later this year, but remember that many people thought rates would rise last year, but rates remained low. While we can’t predict the future, we can consider how rates might change and how we might prepare our portfolios for a range of possible outcomes.
These three possible changes in interest rates show just how tough it can be to prepare for rate changes in advance. Interest rates rise for different reasons and in different ways, and higher rates don’t affect all bonds in the same way. But there are a few things we can do, such as:
Accept that We Can’t Predict Rate Changes
No one knows for sure when rates will rise or how they will rise, and even the experts often get it wrong. In January 2014, 97% of the economists surveyed by Bloomberg predicted rates would increase in the next six months, but rates actually fell. Fidelity found that over the last 15 years, “professional rate prognosticators have consistently anticipated higher rates, and have consistently been wrong.”
Adapt as Markets Change
Rather than trying to predict how rates might change, we rely on our active Upgrading strategy to help us respond to changing market conditions. In the event of a broad bond market sell-off, as we experienced in the 2008 credit crisis, we could move the Flexible Income and Total Return Funds’ bond exposure entirely into high-grade short-term bonds, which have been considered a safer area of fixed income.
Hold a Balanced Portfolio
Investing in a balanced portfolio that includes both stocks and bonds is another way to weather changing interest rates. Stocks aren’t as correlated to gradual rate hikes, and if stocks had gains, this could compensate for losses from bonds. And if stock market volatility picked up, bonds could help cushion the volatility of stocks.
Upgrader Fund investors can find a mix of stock and bond funds in the Conservative Upgrader Fund (RELAX), which keeps about 60% invested in diversified stock funds and 40% in bond funds. The Flexible Total Return Fund (TOTLX) may hold total return funds, like balanced funds, which typically have exposure to stocks and bonds, or alternative funds, which may not be as correlated to stock or bond markets. Because total return funds have limited (or no) exposure to bonds, they are typically less affected by interest-rate fluctuations.