Selling In A Bear Market

Interest Rates and Bonds

Interest Rates and Bonds

The Inverse Relationship of Interest Rates and Bond Prices

What we’ve seen since the early 1980’s is a long trend of steadily decreasing interest rates. The chart below showcases this point.

Since declining interest rates mean higher bond prices this trend has driven the price of bonds up steadily over the last 40 years! At the same time, it is now making it increasingly difficult for bond traders to produce an attractive yield. Does this mean that the fixed income class no longer has a place in your portfolio? Not necessarily. The overall stability bonds can bring to a portfolio, and the consistent cash flow can still have its appeal. That said, we need to be cautious, and consider what may happen if and when interest rates begin to rise again. How might this impact the price of bonds?

The two tables below offer an oversimplified illustration of both scenarios. The first shows a drop in interest rates and how this increases the value of a bond. The second shows the reverse, and what happens when interest rates go up. For simplicity sake, we are ignoring the time value of money and assuming that the rate of inflation is zero. We are also not taking tax calculations into consideration, nor things like credit quality and credit ratings. The table is focused only on how interest rates can move the price of a bond.

Scenario 1: Interest Rates Decline on a 20 Year Bond from 2.0% to 0.5%:

2.0%$100.00$40.00$ 140.000.00%
1.5%$100.00$30.00$ 130.007.14%
1.0%$100.00$20.00$ 120.0014.3%
0.5%$100.00$10.00$ 110.0021.4%

In this scenario a drop from 2.0% to 0.5% interest rates resulted in bond prices going up over 21%!

Scenario 2: Interest Rates Rise on a 20 Year Bond from 0.5% to 2.0%

0.5% $ 100.00$ 10.00$ 110.000.00%
1.0%$ 100.00$ 20.00$ 120.00-9.1%
1.5%$ 100.00$ 30.00$ 130.00-18.2%
2.0%$ 100.00$ 40.00$ 140.00-27.3%

Note that we are not saying that this is what will automatically happen if interest rates go up in the future. No one knows if or when rates might rise again, but this is a risk we need to be aware of and prepared to address.

Now consider the same example if the shareholder reinvested the dividend into more shares (as is typically the case witTo offset this risk, we at CH look to diversify our clients within the fixed income class. We add non-Canadian bonds, corporate bonds, and bonds issued in other currencies. Each of these factors can help to mitigate interest rate risk. We also look at alternative asset classes that we have discussed in previous articles. Finally, during our review meetings with clients we continue to focus on your specific tolerance for risk, and the corresponding rate of return that you expect from your investments. We then build a tailor-made investment portfolio to match your particular situation.

Best regards,

Brian Trafford, Chief Investment Officer
& Your CH Financial Team


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We’re looking for aspirational clients who require the whole spectrum of financial services because managing the whole is how we’re able to deliver unbeatable value – it’s our “secret sauce.”If this describes you, let’s set up a meeting andget to know each other.

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We are with you for the long run and are not going anywhere. Jeremy has told us that at these times the numbers tend to scare you, but you haven’t really lost anything if you don’t panic and sell.

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Prior to joining CH Financial as a client, I had been partially managing our investments and using a bank-owned broker for many years, with moderate success. When we became clients of CHF, I quickly realized how little I knew about the complexities of managing investments and the importance of seeking out the best specialists in the industry to assist with my family’s full financial picture.

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Comfortably retired thanks to CH Financial