5 Ways To Protect Your Bond Portfolio From Rising Interest R

The Federal Reserve recently raised its target federal funds rate for the first time since March 2000. This could be just the tip of the iceberg, though, as many experts believe rising inflation and a strengthening economy will spur continued rate hikes for the foreseeable future.

This is bad news for bond investors, since bonds lose value as interest rates rise. The reason stems from the fact coupon rates for most bonds are fixed when the bonds are issued. So, as rates rise and new bonds with higher coupon rates become available, investors are willing to pay less for existing bonds with lower coupon rates.

So what can you do to protect your fixed-income investments as rates rise? Well, here are five ideas to help you, and your portfolio, weather the storm.

1.Treasury Inflation Protected Securities (TIPS)

First issued by the U.S. Treasury in 1997, TIPS are bonds with a portion of their value pegged to the inflation rate. As a result, if inflation rises, so will the value of your TIPS. Since interest rates rarely move higher unless accompanied by rising inflation, TIPS can be a good hedge against higher rates. Because the Federal government issues TIPS, they carry no default risk and are easy to purchase, either through a broker or directly from the government at www.treasurydirect.gov.

TIPS are not for everyone, though. First, while inflation and interest rates often move in tandem, their correlation is not perfect. As a result, it is possible rates could rise even without inflation moving higher. Second, TIPS generally yield less than traditional Treasuries. For example, the 10-year Treasury note recently yielded 4.75 percent, while the corresponding 10-year TIPS yielded just 2.0 percent. And finally, because the principal of TIPS increases with inflation, not the coupon payments, you do not get any benefit from the inflation component of these bonds until they mature.

If you decide TIPS makes sense for you, try to hold them in a tax-sheltered account like a 401(k) or IRA. While TIPS are not subject to state or local taxes, you are required to pay annual federal taxes not only on the interest payments you receive, but also on the inflation-based principal gain, even though you receive no benefit from this gain until your bonds mature.

2.Floating rate loan funds

Floating rate loan funds are mutual funds that invest in adjustable-rate commercial loans. These are a bit like adjustable-rate mortgages, but the loans are issued to large corporations in need of short-term financing. They are unique in that the yields on these loans, also called