Interest Rates on the Rise

Brooke Salvini |

With Spring in the air, change may be on the way.  The Federal Reserve Board could be close to raising the interest rates as we’ve been anticipating for many months.  With that in mind, I wanted to repost information from August 2013 that I sent out as it is timely once again to put the situation into perspective. 

Many of you have been asking my opinion on the current state of the bond market and what to expect in the upcoming year(s) considering the likelihood of interest rate increases. This is a question shared by all of us and recent coverage by media has made the topic seem even more prominent. I would like to share with you a paper published last month by Vanguard discussing the topic.

To briefly summarize, Vanguard believes high quality bonds continue to provide important diversification in an overall portfolio (I agree with this).  In the past, a bond bear market(the worst 12 month decline in bond prices occurred in 1974 and the loss was -13.9%) does not remotely compare to a stock bear market (the worst 12 month loss in stock prices which was -67.6% in 1930).

Interest rates would have to spike 3% in one year to cause intermediate term bonds to decline in price anywhere near the record loss. Such a drastic spike in interest rates has only occurred twice in the United States (in 1980 and 1981). If this did occur again, it would take about 4 years for the returns on an intermediate term bond fund such as Vanguard Total Bond Market Index Fund to recover just from the momentum of reinvesting in bonds with higher coupon rates. If there was a price correction as well, bond returns would recover more quickly.

I believed then and now once again, that you will also find the attached paper very informative.