- By Reprinted with permission of Investment Representative Celine Richardson of Ithaca's EdwardJones
- Business & Technology
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There's no simple answer, of course. If you own stocks, higher interest rates could be a cause for concern, because when interest rates rise, it becomes more expensive for companies to borrow to expand their operations. As a result, these businesses may feel a squeeze on their profitability - and their stock prices. And yet, some businesses are much more affected by rising interest rates than others, so, as an investor, you can't really base your actions on a blanket statement such as: "Higher interest rates are bad for all stocks."
The situation is a little different if you own fixed-income vehicles, such as bonds. When interest rates rise, the value of your bonds will fall. That's because no one will want to pay you the full price for your bonds when he or she can buy new ones issued with a higher interest rate. To sell yours, you'd have to offer them at a "discount" to their face value. On the other hand, if interest rates fall, the value of your existing bonds will rise, so if you were to sell them, you could get a premium price.
Of course, if you're like many people, you don't buy bonds just to sell them. You want to hold them until maturity, when you can expect to get your principal back, assuming it's a quality bond and the issuer doesn't default. And, along the way, you've gotten regular interest payments, which you can use to supplement your cash flow or to reinvest.However, even if you do plan on holding bonds or certificates of deposit (CDs) until maturity, you might want to pay some attention to what's happening with interest rates. After all, if you depend on bonds or CDs for some of your income, and rates are down when these investments mature, you could face a difficult choice: Should you purchase new fixed-income vehicles at current rates, or should you "park" your money somewhere and hope for rates to rise again soon?
Fortunately, you can find a better solution than either of these options. How? By building a "ladder" of fixed-income investments. To build a ladder, you purchase a variety of fixed-income vehicles [any combination of corporate bonds, U.S. government-sponsored enterprise (GSE) and/or Treasury securities, municipal bonds or certificates of deposit] with a wide range of maturities - short-, intermediate- and long-term.
Once you have established a bond ladder, you are prepared for both rising and falling interest rates. When rates are rising, the proceeds from your maturing bonds can be used to invest in new ones at higher levels. When market rates are falling, you'll continue to benefit from the higher rates offered by your longer-term bonds.
In addition to helping you productively reinvest your maturing bond proceeds in all interest rate environments, a well-structured bond ladder may, over time, help you increase the income you earn on your fixed-income portfolio. And, at the very least, by regularly reinvesting part of your portfolio in all market conditions, you may be able to smooth out your returns.
See your financial advisor for help in putting together a fixed-income ladder that can help you meet your needs.
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