…We clearly see signs that long-term interest rates will be heading higher eventually given the massive federal deficits in the U.S. and our country’s reliance on foreign lenders. As such, it makes prudent sense to begin taking steps to help protect your portfolio against rising interest rates…It’s important to understand how, when and where to make the right moves with your fixed-income holdings.
How to Increase Income Now While Guarding Against Rising Rates Later
The massive amounts of government stimulus spending that were spent to combat the financial crisis will inevitably lead to higher inflation and higher interest rates down the road – no question – but it’s likely to happen in different countries and at different times. Timing is the key.
In the U.S., we don’t foresee a sudden surge in inflation or interest rates in the very near future, but it is on the horizon. Right now, economic fundamentals still appear too weak for inflation to take hold, and the Fed intends to keep interest rates low for an “extended period” as they’ve repeatedly broadcast…
Here are four steps we believe you should consider to potentially increase your income in today’s low yield environment … while still helping to protect yourself against higher interest rates down the road:
#1 — Start with the right investment vehicle
We recommend that all but the very largest portfolios utilize mutual funds. They give you professional management and a diversified mix of fixed-income holdings, which can help reduce interest rate and credit risks — two risks you must watch out for.
#2 — Spread your fixed-income dollars across a broad mix of securities with different maturities
This tactic can help increase your income potential without significantly increasing your risk. We suggest owning:
a) a mix of corporate and government bond funds, preferably with shorter durations.
The shorter your maturities, however, the lower the yield, but shorter maturities are also less sensitive to price changes as interest rates fluctuate.
b) perhaps some medium-term maturities and international or emerging market bonds which will kick up your cash flow even more.
Note, however, that higher yields can add more risk too and the same goes for international bonds, which are also sensitive to currency fluctuations.
#3 — Keep your overall portfolio maturity under about 5 years
Maturity, or duration, is measured in years and it is a standard data point provided by mutual funds on their websites although it’s a bit more difficult to calculate it across your entire portfolio of fund holdings. Weiss Capital’s professional oversight helps determine the right blend of income-producing securities and maturities to strike a balance between risk and return potential within the portfolio while helping you maintain cash flow.
#4 — Consider allocating a small portion of your portfolio to inverse funds and foreign currency funds
Such specialty funds, if used prudently, can provide a hedge against currency fluctuations and also hedge against rising interest rates but a small allocation toward these funds is recommended. A word of caution though: They must be used sparingly, chosen carefully and, above all, monitored quite closely. These types of investments are typically not suitable for retail investors who plan to hold them longer than one trading session. Still, when used wisely, or with professional guidance, inverse funds may help reduce the volatility in your portfolio overall. Weiss Capital Management has extensive experience utilizing these securities in pursuit of overall investment objectives.
If you look beyond our borders, you’ll find many countries that may be healthier than the U.S., with stronger currencies than the dollar, and with naturally higher interest rate environments. Keep in mind, however, that such global diversification using international bond funds have unique risks to consider such as differences in accounting standards, political risks, and less corporate transparency…
The comments above are edited ([ ]) and abridged (…) excerpts from the original article by Sharon A. Daniels
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