14 Jul Bonds, interest rates and no crystal ball

 Q. I know interest rates are going up sometime in the future. How do I choose the best bonds for my portfolio?

A. We don’t have a crystal ball, so the future of interest rates — even to experienced market watchers — is something of a mystery.

Before looking at what bonds may be best for you, consider your goal.

It’s important decide what role the bonds will play in your portfolio, said Altair Gobo, a certified financial planner with U.S. Financial Services in Fairfield.

For example, do you hope to preserve principal, maximize income or offset risk of your stock investments?

Gobo said the fixed income allocation in your portfolio should reflect your goals, time horizon and risk tolerance.

He said investing in a portfolio that is similar to the Aggregate Index, which is heavy in Treasuries and has no high yields, or limiting your portfolio to bond funds that invest solely in the U. S. Bond Market may not be the best idea at this time.

You’re correct that the U.S. has been in a low interest rate environment for some time, and there is the prospect for interest rates to rise in the future, especially as the Federal Reserve prepares to increase the Fed Funds rate as soon as this fall, said Andy Kapyrin, director of research for RegentAtlantic Capital in Morristown.

“It’s impossible to know exactly when or exactly how much interest rates will rise, so it’s important to build a bond portfolio that is suited to many different environments,” he said.

He recommends a three-pronged approach.

Kapyrin said he’d start building a bond portfolio by allocating to short-term, high quality bonds.

“Bonds that mature in five years or less and have high credit ratings have historically had very little volatility, and are a good way to be positioned when interest rates rise,” he said.

He said he would also include opportunistic bond managers – mutual fund managers with open ended mandates that permit them to seek out good values across a broad spectrum of bond sectors.

“In rising rate environment, markets may create many opportunities for an open minded manager,” he said.

Lastly, I would be sure to include an allocation to inflation protected bonds.

“Inflation is the biggest risk to bond investors in the long term, and large interest rate increases are often prompted by unexpected jumps in inflation,” Kapyrin said. “A inflation protected bond fund could hedge against this risk.”

As you consider your options, remember the importance of diversification, Gobo said.

“Since your overall portfolio is purposely not made up of one investment, your fixed income allocation in your portfolio should also be diversified,” he said. “A typical diversified fixed income portfolio would consist of short and intermediate positions, corporate, municipal, mortgage-backed, high yield, international and global funds as well.”

Gobo said you may want to consult with a financial or tax advisor to determine if a tax-free bond fund would be appropriate.

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This story was first posted in July 2015.