How do I Manage Interest Rate Risk?

Interest-rate risk can cost you money.
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Fixed-income investments like certificates of deposit, individual bonds and bond funds allow investors to enjoy a current stream of income along with the promise of future appreciation. But these investments are not without risk, and it is important for investors to be aware of that fact. Fixed-income investments are impacted by changes in interest rates, and investors need to take steps to mitigate that interest- rate risk.

Step 1

Build a ladder of certificates of deposits (CDs) rather than buying a single CD with a fixed maturity date. Divide your investment capital into five segments, then invest one segment each in a one-year, two-year, three-year, four-year and five-year CD. This strategy allows you to capture the higher returns available on longer term CDs without risking that all your money will come due during a low interest rate environment.

Step 2

Review the annual report you receive from each bond fund you own. Find the average maturity as listed in the annual report. Bond funds with an average maturity of only one to two years are far less sensitive to changes in interest rates than funds with longer average maturity levels.

Step 3

Make a list of all the fixed-income investments you own, including bonds, bond funds, certificates of deposit and money market funds. Make sure you have sufficient short-term cash in a money market fund or savings account to cushion you in an emergency. Spread the rest of your fixed-income investments among short-term bond funds, bonds with a fixed maturity and bank CDs.

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