Most of the time, we like to think that more is more. More friends, more vacations to beautiful places, more time in the day. In situations like these, it’s usually better to have more than less.
But sometimes, less is more. In stock investing, a short-term trade can make you money. In the bond world, shorter-term bonds can mean less risk. And these days, with interest rates likely to rise, reducing risk in your bond portfolio may be more important than ever.
Short term bonds can fare better in higher interest rate environments. Why? In general, when interest rates go up across the curve, bond prices go down. But here’s the key—short term bond prices go down less.
Think of it this way. If you own a long term bond, and interest rates rise, if you sell that bond before maturity, you’ll get less than what you paid for it. If you own a short term bond and interest rates rise, the price will not be affected as drastically as with a long term bond because interest rates are less likely to fluctuate drastically in the short term. My colleague Matt Tucker explains this further in a Blog post on duration.
With interest rates on the rise, investors need to consider the impact on their bond portfolio. Bond portfolios that have lots of long-term bonds may be at risk of serious losses. And investors sitting on cash may feel like they have nowhere to go, stuck between getting back into a nasty bond market or a volatile stock market.
So what’s an investor to do?
If you have a bond portfolio that’s heavy with long-term bonds, you can potentially reduce your interest rate risk by rebalancing your portfolio to increase exposure to short-term bond ETFs. The iShares Short Maturity Bond ETF(NEAR) seeks to maximize income through diversified exposure to short-term bonds. With one fund, you can potentially add diversification while seeking to reduce your interest rate risk at the same time. You don’t have to shift your entire bond portfolio to shorter-term bonds; just enough to balance the rest of your long-term bond portfolio.
Or, maybe you’re sitting on cash. You know that every day spent sitting on cash is a day that your money is not working for you, but you’re stuck. Maybe you feel a little bit like Goldilocks: you’re equally nervous about the bond market (too risky to buy long term bonds now, if they’re about to lose money!) and the stock market (too volatile). For you, short-term bond ETFs may be just right. Put your cash back to work with something like the iShares Floating Rate Bond ETF (FLOT), which offers access to 300+ investment-grade floating rate short-term bonds in a single package. Floating rate note coupons are designed to rise with short-term interest rates, which can help you keep up when short-term rates rise.
Regardless if you’re starting out with long-term bonds, or no bonds at all, toe dipping into short-term bonds can help you stay invested in the bond market—no matter where interest rates go.