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May 5, 2022, 9:31 a.m. EDT

Here’s how you can play it safe with your investments as interest rates rise

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By Philip van Doorn

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Since most bond funds are managed to maintain their average duration, Hulbert cited research showing that a good rule of thumb is that if you hold a bond fund in a rising-rate environment and your share price falls, the replacement of maturing bonds with higher-paying bonds will make up for that decline if you hold on to your investment for a period of at least one year less than twice the fund’s average duration.

So for Vanguard’s VGIT, that would mean being able to stay in for almost 10 more years. Would you be able to do that without worrying through the worst period for price declines? If so, a bond fund with a similar duration remains a viable way to diversify your portfolio away from stocks.

The case for owning bonds until maturity

If you buy your own bonds and hold them until maturity, you know how much you will be paid back when the bonds mature. You might have an easier time navigating a period of declining bond prices than you would if you were watching your bond-fund share price decline.

Ken Roberts, a registered investment adviser with Four Star Wealth Management based in Truckee, Calif., helps income-seeking clients with strategies in the bond and stock markets. He discussed various income strategies during an interview.

First, here’s a list of yields on May 4 for U.S. Treasury securities of various terms:

Maturity Yield on May 4
3 months 0.860%
6 months 1.406%
1 year 2.045%
2 years 2.756%
3 years 2.836%
5 years 2.906%
7 years 3.022%
10 years 2.963%
20 years 3.237%
30 years 3.006%

Click on the maturities in the left column to go directly to that Treasury security’s quote page.

The above shows the yield curve for U.S. Treasury securities. Interest paid on Treasury bills, notes and bonds is exempt from state and local taxes. Depending on your tax situation, you might prefer to invest in municipal bonds, which are exempt from federal income taxes.

The Treasury table provides a good indication of the overall bond-market rate curve, and you can see that three-year and five-year notes have higher yields than 10-year notes. This has been an indicator of previous recessions, however, it might have a very long lead time .

Roberts outlined three typical strategies for bond portfolios:

  • Bullets . This strategy means loading up on intermediate-term bonds. Three-year U.S. Treasury notes /zigman2/quotes/211347047/realtime BX:TMUBMUSD03Y +0.69% have a yield close to that of 10-year Treasury Bonds /zigman2/quotes/211347051/realtime BX:TMUBMUSD10Y +1.40% and even 30-year bonds /zigman2/quotes/211347052/realtime BX:TMUBMUSD30Y +0.06% .

  • Barbells . This means allocating to the short and long sides of the yield curve. The advantage on the short side is quick maturities that might be replaced with higher-yielding paper as rates rise. This strategy “probably isn’t best” for the current rate environment, according to Roberts. “The bullets make more sense,” he said.

  • Ladders. This is a strategy followed by many bond funds. It “probably works best when the yield curve is normal,” Roberts said. A normal yield curve is one in which longer maturities have progressively higher yields. He provided this example: If you have $200,000 to invest in bonds and want to do a 20-year ladder, you can allocate $10,000 for a bond that matures a year from now and so on, out to 20 years. “Then you have one maturing every year. So if rates rise, you go out further and lock in rates. If rates fall, you lock in gains. It is a good strategy to work with for different interest rates,” Roberts said.

These strategies may seem complicated, but they are typical ones that you can follow with the assistance of a broker of investment advisor.

Other Treasury bond strategies

TIPS

TIPS stands for Treasury Inflation-Protected Securities, which pay interest twice a year and have their principal amounts adjusted upward, based on the inflation rate, or downward if there is deflation. The interest rate is applied to the adjusted principal, so these securities offer good protection for investors in a high-inflation environment.

Roberts pointed out that investors can participate in TIPS in an easier way, with an exchange traded fund, such as the iShares TIPS Bond ETF /zigman2/quotes/200600110/composite TIP -0.04% . The ETF pays a monthly dividend.

A more sophisticated strategy for the TIP ETF is to make use of covered-call options to increase income. You can read about covered-call income strategies in detail here .

I-Bonds

Series I savings bonds are available directly from the Treasury. It is easy to set up an online Treasury Direct account. Savings bonds might seem to be a quaint notion until you realize that I-Bonds are now yielding 9.62%. The rate is adjusted every six months, in May and November, based on the U.S. inflation rate. Interest is added to the bonds and paid when you redeem them.

I-bonds must be held for at least a year. They can be redeemed after five years with no penalty. If you redeem earlier, the penalty is three months’ interest. Keeping in mind that this is money you wish to invest for the long term outside the stock market, that penalty isn’t very high, especially when inflation and the I bonds’ interest rates are so high.

Treasury Direct accounts are set up as individual or corporate accounts. The regular limit for annual purchases of I-Bonds is $10,000. However, you can also receive I-Bonds in place of your federal tax refund, up to $5,000 a year. For a couple, two individual accounts make for a regular annual limit of $20,000.

Hulbert digs further into I-Bonds and their tax implications here .

Don’t miss: These 10 dividend stocks with yields of at least 5% can help you take on stagflation or a recession

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