Last week we discussed the effect of rising interest rates on fixed-income portfolios and how this negative effect is magnified when starting from a low-interest-rate environment. So what can we do about it?
If you follow a couch potato-style portfolio then, in theory, you shouldn't do anything other than stick to your rebalancing protocol. Generally speaking, that means rebalancing your portfolio at set time intervals - usually once a year - or rebalancing based on the degree of deviation from your target asset class allocations.
For example, if your portfolio is set to have a 40-per-cent allocation to Canadian fixed income and this drops by more than 5 per cent, only then would you rebalance. This leads to less frequent rebalancing in less volatile markets and more frequent rebalancing in more volatile markets.
The approach you take is is up to you, but it's important to stick with it. It naturally forces you to sell off winning asset classes while the going is good and double down on losing asset classes when opportunities are more ripe. The tradeoff is that sometimes you sell off some of your winners before they're fully done winning. Vice versa, sometimes you end up adding money to asset classes that are not done losing.
But what if you're not a couch potato investor? Or maybe you're a couch potato investor who plays fast and loose with some of the rules, as many do.
If you hold individual bonds, then as long as you plan on holding them to maturity, you don't have anything to worry about; except of course if the issuer defaults. While bond prices may drop and fluctuate wildly over time with potentially successive interest rate increases, they'll eventually mature at par value. You just have to hold on for the ride in the meantime.
Shorter-term bonds will tend to drop less in price than longer-term bonds with rising rates, so many investors consider tilting their fixed-income portfolios toward the shorter end of the curve during an expected rising interest rate environment.
If you use an actively managed bond fund, then the manager is taking into account the interest rate environment and more. So presumably you don't have to make any changes and let them do what they were hired to do.
Whatever you decide to do, talk to your adviser first or do some research of your own. Talk about the range of possibilities too. We don't know when and how interest rates will rise. But with a long-term portfolio approach, generally speaking, if you simply stick to a well-thought out plan, you'll be fine if you have an understanding of what short-term hiccups you can expect.
Preet Banerjee is a senior vice-president with Pro-Financial Asset Management. His website is wheredoesallmymoneygo.com .