CHICAGO (Reuters) – Now that the U.S. Federal Reserve has announced it might wind down its stimulus program, and as rates rise, it’s critical to adjust your portfolio.
Bond prices fell as yields rose to a near two-year high on Monday. The U.S. Treasury sell-off was sparked Fed Chairman Ben Bernanke’s comments the central bank might begin scaling back purchases of Treasury and mortgage securities later this year.
The impact of rising interest rates, which depress bond prices, are measured directly through duration. Duration measures a bond portfolio’s sensitivity to rates. For each one-percentage point uptick in rates, the duration gauge shows you how much money you can lose in principal. Generally, the longer the duration, the greater the chance you’ll lose money.
Say you have an investment-grade bond with a duration of 14.5 years that carries a 4.5 percent coupon and matures in 30 years. If rates tick up two percentage points, you could lose 26 percent of the bond’s market value. Every bond portfolio prospectus or website should give you duration measures. They can also be found on any financial portal online.
Of course, this is an extreme example, but you need to be careful to insure your portfolio is insulated from interest-rate risk, which is highest for long-maturity bonds.