July 12, 2022

If you’re curious about what’s been going on with interest rates, and your bond portfolio, let me explain some of what is going on. Most likely, the bonds in your 401(k), and often those in your IRA, are in bond funds. Bond mutual funds and bond exchange-traded funds are pooled investment vehicles that invest primarily in bonds (municipal, corporate, et cetera) and other debt instruments such as mortgage-backed securities. The primary goal of a bond fund is often to generate monthly income for investors. ⁽¹⁾

A secondary goal for many investors choosing to allocate all or a portion of their investments into bonds or bond funds is stability. Because these investments tend to be less risky, you will receive the potential for lower returns. Also, individual bonds repay their original amount (usually a multiple of $1,000), also called “principal” or “par value” at maturity, which allows investors to recoup all or part of their initial investment at that time. ⁽²⁾

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Bonds and interest rates are inversely correlated – which means that when interest rates in the marketplace go up, the value of existing bonds will fall. Because interest rates have been rising, a hypothetical investor sees the bonds held in their bond fund decrease in value, and since a bond fund is a pooled investment, they do not have a maturity date to rely on to receive their money back.

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An alternative to investing in bond funds would be to invest in individual bonds. Unlike a bond fund, you do receive principal back at maturity, and so the price changes become less of a concern for you. It can be stressful seeing the value of your bond decrease, but the payments you receive are unaffected, as long as the issuer is not in bankruptcy. ⁽²⁾

On the other hand, individual bonds are less diversified compared to bond funds. You are relying on the bond issuer to pay their debts and not default. With a bond fund, you have instant diversification, a portion of your investment in many different companies. When choosing individual bonds, more care must be taken to identify companies unlikely to default.

As well, many 401(k), 403(b), and other employer-sponsored retirement plans do not offer individual bonds as an investment option. Many investors also feel they lack the information or experience to choose individual bonds, preferring the diversification of a bond fund even if it comes with a downside. Still, it can be worth exploring your options to see what may be good fit for you and your financial plan.

Contact me to learn more about these and other investment strategies, and how to achieve your short- and long-term financial goals.