Bond mutual funds have clearly benefited from the multi-year period of historically low interest rates. But that outperformance may not last as the Federal Reserve is widely expected to finally raise interest rates at some point in the next few months. Investors may want to consider interest rate risk in the fixed-income market before investing.
Strong Performance of Bond Funds
Other types of fixed income are also benefiting from low rates, not just high-yield bonds. For example, U.S. Treasury bonds have provided satisfactory returns. The U.S. 10-Year Treasury Bond yield remains at 2.1%, which has kept investor appetite for Treasury bonds robust. Mutual funds oriented towards government bonds are benefiting from this as well. However, bonds will be adversely affected by rising rates. Here is what investors should know about rising rates and what they mean for fixed income.
The Impact of Rising Rates
An investor will likely sell these previously issued bonds to reinvest in newer, higher yielding issues. To incentivize investors to buy lower yielding, older bonds, the price will need to decline to make the yield competitive with newer, higher yielding securities.
Consider Risks before Investing
This should negatively impact bond mutual funds. Higher interest rates typically result in lower prices of fixed-income securities since yield and price are inversely related. As interest rates increase, prices tend to decrease in order for bond yields to rise accordingly with rates. Therefore, the rally in bond mutual funds this year could prove to be short-lived.
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