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Bond Funds and Rising Interest Rates

Many investors who purchased bonds as the “safe” investment in their portfolio could soon be in for an unwelcome surprise when they see their account statements. That’s because of an anticipated rise in interest rates as the Federal Reserve begins to start slowing its bond-buying program sometime this year.

When the Fed will actually begin tapering its asset-purchase program – known as quantitative easing – is anyone’s guess. And that lack of clarity translates into confusion for many investors.

During times of higher interest rates, bond funds are at a particular risk for both investors who are invested in an individual bond, as well as shareholders in a bond fund. When interest rates rise, bond prices go down. For shareholders in a bond fund, however, the issue is compounded by the fact that the fund manager of the bond fund may be forced to prematurely sell off individual bonds within the bond fund to meet redemption requests by shareholders wanting to liquidate their shares. This, in turn, can have a catastrophic effect on the net asset value of the bond fund.

Making matters even worse is the fact that the majority of investors appear to be unaware about the impact of rising interest rates on their investment portfolio and, more important, what they should do.

A recent Edward Jones survey showed that 63% of the individuals surveyed believe that rising rates matter but don’t know what to do about it in their 401(k) or IRA. Another 24% of Americans said they “do not understand this at all.”

The bottom line: It’s impossible to predict the future when it comes to the current financial climate, but preparation is and always will be key.

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