Bonds are sometimes thought of as safer investments than stocks because their market prices tend to be less volatile, but that doesn't mean bonds are without risk. Even ultra-safe U.S. Treasury bonds are subject to price fluctuations in the secondary market. If prevailing interest rates rise and you need to sell your bonds, you could take a loss. Having a strategy in place beforehand can help protect your bond investments during periods of rising interest rates.
One of the key risk-management strategies for investing is diversification. If you put all of your money into one bond, and the bond issuer goes bankrupt, you lose all your money. When you diversify your investments by purchasing bonds from several different issuers, if one bond issuer goes belly-up only a portion of your investment dollars are affected. This is the basic strategy employed by bond mutual funds. But diversification doesn't protect you against price declines due to rising rates, since all of the bonds in your portfolio will be affected.
Buy and Hold
If you have the financial resources to ride out temporary fiscal storms, employing a buy-and-hold strategy on your bonds might be your best bet. As long as you hold your bonds until they mature, you can redeem them at full face value, regardless of whether prevailing interest rates rise or fall.
Longer term bonds involve a greater degree of risk than shorter term bonds, and typically pay a higher interest rate to compensate for that added risk. One strategy for dealing with periods of rising interest rates is to make short-term bond investments. You might give up a bit of interest, but you can significantly reduce your risk of loss if you have to sell prior to maturity.
A bond fund manager's ability to protect your assets during periods of rising interest rates is limited because of the fund's investment objectives. You can gain greater control of your investments by creating a diversified bond ladder. This involves buying bonds with a succession of maturity dates. Each bond represents a rung on your ladder. As each bond matures, you can reinvest the proceeds in a bond with a higher interest rate.
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.