Read the weekly bond market commentary from Drew O’Neil

April 9, 2018

The fear of potentially rising rates is irrationally keeping some investors’ fixed income dollars either on the sidelines or misallocated to other asset classes. The reason for this irrational fear is that the effect a rising interest rate environment has on a portfolio of individual bonds is often misunderstood. It is important for investors to remember what makes up the return on a portfolio of bonds: Price Return + Coupon Return + Interest on Reinvested Cash Flow = Total Return.

  • Coupon return will remain constant regardless of what interest rates do.
  • Interest on reinvested cash flow will be higher in a higher rate environment.
  • Price movement is temporary, the price will eventually end up at par regardless of what interest rates do.

The chart below depicts total return numbers1 for a 5-10 year bond ladder in an extreme example (a 3% rise in interest rates), at yearly increments out to 5 years. A 3% increase in yields is a situation that most headlines and talking heads proclaim would be a “bloodbath” for fixed income investors. Over a 5 year timeframe, an investor would experience a 16% positive return were this rise in interest rates to play out — far from a bloodbath.

Sources: Tradeweb Direct LLC, Raymond James

So where is the disconnect between the headlines and reality? Most of the headlines you are reading are short-sighted and concerned with instantaneous reactions. As an investor working towards a long-term financial goal, you are interested in the long-term effects and how a rise in interest rates is going to affect you 5, 10, or 20 years down the road. The negative commentary on a rising interest rate environment is only focused on one portion of the equation (price return) and completely ignores the other two (coupon return and interest on reinvested cash flow), which is where the disconnect is. As seen below, all three of these components must be considered to get the complete picture.

Sources: Tradeweb Direct LLC, Raymond James

So what is the takeaway here? The beauty of individual bonds is that they have the advantage of a maturity date and a defined stream of cash flow, which puts the advantage of time on the investor’s side. Short-term price fluctuations are temporary while the positive impacts of cash flow will build over time.

1 Outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. 


To learn more about the risks and rewards of investing in fixed income, please access the Securities Industry and Financial Markets Association’s “Learn More” section of investinginbonds.com, FINRA’s “Smart Bond Investing” section of finra.org, and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) “Education Center” section of emma.msrb.org.

The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.

By | 2018-04-11T10:37:53+00:00 April 11th, 2018|Latest Articles|