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Did you know that an allocation to fixed income in a well-diversified portfolio can not only provide a source of interest income, but can help preserve capital in periods of equity market volatility?

Although it’s unsettling to see rates go up given the short-term implications for fixed income, higher rates are actually not as bad as they seem over the long term. Let’s explore the impact of rising rates on bonds.

Although less prone than equities to large changes in value, bonds are subject to risks of their own.

A bond’s yield is influenced by the current market climate, meaning how much investors can demand for lending money to an issuer for a specified period of time. The yield of a bond is also based on the price paid for the bond, its coupon and its term-to-maturity.

The creditworthiness of the issuer
The overall economic outlook and inflation rate
Changes to interest rates set by central banks

Another term often used in discussions about bonds is duration, a measurement of how sensitive bonds are to changes in interest rates. It is expressed as a number of years. Typically, the further away a bond is from its maturity date, the longer its duration and the greater the price change could be when yields move.

An inverse relationship

A bond’s yield and price have an inverse relationship, meaning they move in opposite directions.

It’s important to remember that, even though bond prices fall when yields rise, your current coupon or interest payments can be reinvested at this new higher rate. Over time, that higher reinvestment rate will help offset the fall in the bond’s price. As a general rule, if a bond has a four-year duration, its price would either rise or fall by four percent for every one percent change in yield.

bond yield price inverse diagram en

To learn more about fixed income investing, talk to your financial advisor.

Disclosure

This has been provided by RBC Global Asset Management Inc. (RBC GAM) and is for informational purposes only. It is not intended to provide legal, accounting, tax, investment, financial or other advice and such information should not be relied upon for providing such advice.