Investing money the right way: Should I consider investing in bonds now that interest rates are higher? -CNBC | Jewelry Dukan

Welcome to Select’s latest advice column, get your money right. Financial Advisor Kristin O’Keeffe Merrick answers your pressing money questions. (You can read her last part here how to diversify an investment portfolio to reduce risks and losses.) Do you have a question you want to ask? Send us a message at AskSelect@nbcuni.com.

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Dear Kristin,

I’m a relatively new investor and have only invested in stocks so far. I’ve been reading more about the bond market and not sure if this is a good time to do so Start investing in bonds now that interest rates have risen. Can you tell me more about investing in bonds so I can decide if it makes sense for me?

Signed,

Bondy in Baltimore

Dear Bondi,

This is an incredibly timely question that I’ve answered for many clients lately. Before we get into that, however, I need to provide some context on interest rates and their equivalent to bonds.

In the last 15 years we have seen historically low or declining interest rates. For many investors, this is the first time they have experienced a rising interest rate environment, so it’s important to understand how this rise in interest rates may affect your portfolio over the coming months and years – especially as many of the strategies we explore in As years past have used, with varying degrees of success, may not have been as effective with this recent rise in interest rates.

When interest rates rise, bond prices fall in value. Most bonds pay a fixed coupon (ie interest payment) and when interest rates rise, a fixed coupon can only equate to a higher interest rate if the investor pays less for the bond. A bond’s duration is a measure of its price sensitivity to a change in interest rates. Duration is a function of maturity, so the longer a bond’s maturity, the longer its duration will be. The price of a longer-dated bond is therefore more sensitive to changes in interest rates than a shorter-dated bond, all other factors being equal.

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With that in mind, let’s return to my earlier point. When interest rates are rising and bond prices are falling, why would I want you to think about bonds?

First, as a general asset class, bonds have a lower measure of risk than stocks. Second, bonds generally pay you a coupon — monthly or quarterly, depending on the bond — that provides you with income as part of your investment. When interest rates rise, bonds pay higher coupons.

However, bonds in general can be complicated and are not without risk. You need to consider interest rates and credit risk – how worthy the borrower or issuer is – before jumping in.

Shortening the maturity of your bonds helps limit the potential damage that can come from rising interest rates. If you can try to eliminate interest rate risk through hedging, bonds become a lot more interesting.

There are investment strategies that focus on short duration, while others focus more on products that hedge the interest rate of bonds, which essentially mitigates risk and makes interest rate movements much less impactful.

An example of an interest rate-hedged bond strategy is when you invest in portfolios of investment-grade or high-yield bonds and include built-in hedging to mitigate the impact of rising Treasury rates. In most cases, these products do their best to eliminate interest rate risk, while short duration strategies only limit your exposure. You can also express this through asset classes such as investment grade floating rate notes, bank loans and government inflation linked bonds or TIPS.

All of this can be expressed through exchange-traded funds, also known as ETFs, and mutual funds. When looking for the funds that are best for you, consider track records and expense ratios before making a decision. You should also consult a financial advisor if you have one.

You should look for products that benchmark the FTSE Corporate Investment Grade (Treasury Rate-Hedged) Index for investment grade bonds or the FTSE High Yield (Treasury Rate-Hedged) Index for high yield bonds to help you make the right decision .

When interest rates rise, you should also consider your stock portfolio. Just because interest rates are rising doesn’t mean you can’t still invest in stocks and make money. However, not all stocks react the same way in a rising interest rate environment, so it’s important to research this beforehand.

Certain sectors, such as financials, have been historical high-flyers. Energy and materials have also performed well due to the rise in prices (inflation) that comes with rising interest rates.

Personally, I’ve focused on stocks that pay dividends. These types of stocks are generally lower risk, are historically solid companies with long track records, and have cash to offset market volatility — plus they pay you dividends.

There are many ETFs and mutual funds that focus on this type of investment, which goes by many names, including stock income funds or growing dividend funds. There are also ETFs you can buy that focus solely on rising interest rates and the sectors and stocks most closely correlated with it.

That’s a lot to put up with as a new investor. My advice is to always do your research, ask questions and hire a financial advisor if this is too overwhelming for you. My other advice is don’t become an expert on Bond math – it really is the most boring thing in the world. Much luck!

If you’re looking to buy bonds through mutual funds or ETFs, consider a broker like Vanguard or Fidelity, which doesn’t charge commission fees. Additionally, a robo-advisor such as Wealthfront or Betterment can put together a customized portfolio for you based on your risk tolerance, and generally bonds will be included in the mix of assets they select for you.

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    Minimum deposit and balance requirements may vary depending on the investment vehicle chosen. For Betterment Digital Investing, minimum balance of $0; Premium Investing requires a minimum balance of $100,000

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Kristin O’Keeffe Merrick is a Financial Advisor and Money Specialist at her family business, O’Keeffe Financial Partners, based in Fairfield, NJ.

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Editorial note: Any opinion, analysis, review, or recommendation expressed in this article is solely that of Select’s editors and has not been reviewed, approved, or otherwise endorsed by any third party.

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