Continue reading...One of the asset classes that can be productively used by many investors is fixed-income investments – bonds. I have been asked several times recently about the wisdom of investing in bonds in an environment of rising interest rates. That’s what I’ll address here.
The reason that the question comes up is that when interest rates go up, the value of all existing fixed-rate bonds goes down. If we expect that interest rates will go up, as most people do, then are we not saying that the value of any bonds that we invest in will go down? Could we have a net loss on the bond investments? If so, should we avoid bonds until we think that rates have peaked out? Or is there something else that can be done?
First, let’s briefly review the relationship between interest rates and bond prices. The rate of interest that a bond issuer originally set on the bonds was the lowest amount that they could pay at the time, given the general price level of money – i.e. the prevailing interest rates. The...
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