For the last several years, investors have been warned that bond prices could drop as interest rates—and bond yields—rise, potentially hurting nest eggs. However, aside from a few sporadic upticks, bond yields have remained depressed for the last six years, and many think that’s unlikely to change soon. The Federal Reserve hinted at raising interest rates last December but has made no further changes. Britain’s recent decision to leave the European Union may prevent additional action, as leaders remain cautious about Brexit’s impact on the global economy.
Additionally, bond yield increases aren’t entirely a bad thing. Over the long term, rising rates can boost returns on a diversified portfolio of bonds because investors can re-invest interest income and proceeds from maturing bonds at the higher rates. And while bond prices do decline when interest rates rise, the losses are typically much smaller than the ones experienced during stock market dives.
There are also steps investors can take to boost protection from rising rates. Diversifying, investing in short-term bond funds, and including international bond funds can help. Investors using taxable accounts could also consider adding high-quality municipal bond funds to their mix.
Whatever may happen with yields, though, bonds are still a good way to diversify a portfolio and serve as a more stable counterweight when stock markets grow volatile. In fact, a recent Vanguard analysis1 found that, during the worst months of stock performance between 1988 and August 2015, high-quality bonds performed better than other alternatives, including commodities, dividend stocks, hedge funds, and REITs.
1 Kinniry, Fran. "High-quality Bonds-The Rodney Dangerfield of Investments." Vanguard Blog for Institutional Investors. The Vanguard Group, Inc., 15 Oct. 2015. Web.