The Federal Reserve could announce an interest rate hike next week. Consequently, fixed-income investors may want to think about ways to limit the negative impact of rising rates, such as moving down the yield curve to short-term bond exchange traded funds.
When interest rates rise, the price of older bonds with lower rates fall. Since new bonds are issued at the newer and higher rates, investors would be less inclined to hold older debt securities with lower yields. Consequently, the less appealing older bonds will see prices fall.
For bond ETFs, investors should look at the duration, or a bond fund’s measure of sensitivity to changes in interest rates, so a higher duration means a higher sensitivity to shifts in rates.
“If that’s the type of interest-rate sensitivity that keeps you up at night, then consider moving to shorter-term bonds,” Greg McBride, senior vice president and chief financial analyst for Bankrate.com, told CNBC.
For instance, for a diversified short-term bond ETF approach, investors may take a look at something like the iShares Core 1-5 Year USD Bond ETF (NYSEArca: ISTB), which has a 2.67 year duration and a 1.92% 30-day SEC yield. ISTB holds a broad range of investment- and speculative-grade bond exposure, including 45.1% Treasuries, 16.7% industrial, 11.8% financial, 9.3% agency, 8.1% MBS pass-through, 2.5% supranational, 2.2% sovereign, 1.3% utility and 1.2% CMBS.
Tim Maurer, director of personal finance at the BAM Alliance, also cautions investors from getting too fancy with their portfolio changes
“Consider risking abject boredom with your fixed-income allocation, investing in short-term Treasuries, FDIC-insured CDs and only the highest-rated diversified municipal bonds. These securities typically should not respond with high volatility if or when interest rates rise,” Maurer told CNBC.
For Treasury bond exposure, short-term ETF options include the iShares 1-3 Year Treasury Bond ETF (NYSEArca: SHY), which has a 1.85 year duration and a 0.7% 30-day SEC yield, Schwab Short-Term U.S. Treasury ETF (NYSEArca: SCHO), which has a 1.9 year duration and a 0.82% 30-day SEC yield, and Vanguard Short-Term Government Bond ETF (NYSEArca: VGSH), which has a 1.9 year duration and a 0.83% 30-day SEC yield.
Additionally, there are a number of short-term, investment-grade municipal bond ETFs available, including the SPDR Nuveen Barclays Short Term Municipal Bond ETF (NYSEArca: SHM), which has a 2.85 year duration and a 0.83% 30-day SEC yield, Market Vectors-Short Municipal ETF (NYSEArca: SMB), which has a 2.91 year duration and a 1.08% 30-day SEC yield, and iShares Short Term National AMT-Free Muni Bond ETF (NYSEArca: SUB), which has a 2.01 year duration and a 0.59% 30-day SEC yield.
For more information on the fixed-income market, visit our bond ETFs category.
Max Chen contributed to this article.