Whether you invest in bond funds or buy bonds on your own, most experts recommend that investors modify their bond strategy rather than abandon bonds altogether when interest rates are expected to rise. Not only do bonds have the potential to provide steady income and portfolio stability, but no one knows with absolute certainty whether interest rates will move up or down, and how far or how fast. You want to be in a good position to benefit and protect your portfolio regardless of whether economic conditions live up to expectations — or confound them.
One strategy is to emphasize short- and mid-term bonds and bond funds of 1- to 5-year maturities, while maintaining a moderate allocation in long-term bonds of 10 years or more for portfolio balance and
diversification.
And if you buy individual bonds, you may be able to ride out some of the interest rate fluctuations by holding your bonds until
maturity.
Laddering
Laddering is one strategy that can limit
interest-rate
and
inflation
risk, while providing flexibility in a portfolio of individual bonds. Instead of investing the entire amount you've allocated to bonds in one issue that matures on a particular date, you divide your investment across three or four bond issues with similar ratings but different maturities. The shortest
term might be 1 year, the next one 3 years, and the third one 5 years.
If interest rates have gone up when one of your bonds matures, you'll be able to reinvest your principal at a
higher rate. And if interest rates have fallen, you can reinvest the money — in bonds or another type of investment — or use the money to pay expenses without having to sell off the rest of your bond holdings.
