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Investors need to be careful, though. Most floating rate loans are made to below-investment-grade companies. While there are provisions in these loans to help ease
pain in case of a default, investors should still look for funds that have a broadly diversified portfolio and a good track record for avoiding troubled companies.
3.Short-term bond funds
Another option for bond investors is to shift their holdings from intermediate and long-term bond funds into short-term bond funds (those with average maturities between 1 and 3 years). While prices of short-term bond funds do fall when interest rates rise, they do not fall as fast or as far as their longer-term cousins. And historically, decline in value of these short-term bond funds is more than offset by their yields, which gradually increase as rates climb.
4.Money-market funds
If capital preservation is your concern, money market funds are for you. A money-market fund is a special type of mutual fund that invests only in very short-term money market instruments. Since these instruments usually mature within 60 days, they are not affected by changes in market interest rates. As a result, funds that invest in them are able to maintain a stable net asset value, usually $1.00 per share, even when interest rates climb.
While money-market funds are safe, their yields are so low they hardly qualify as investments. In fact, average seven-day yield on money-market funds is just 0.70 percent. Since average management fee for these funds is 0.60 percent, it does not take a genius to see that putting your capital in a money-market fund is only slightly better than stashing it under your mattress. But, because yields on money-market funds track changes in market rates with only a short lag, these funds could be yielding substantially more than 0.70 percent by end of year if Federal Reserve continues to hike rates as expected.
5.Bond ladders
“Laddering” your bond portfolio simply means buying individual bonds with staggered maturities and holding them until they mature. Since you are holding these bonds for their full duration, you will be able to redeem them for face value regardless of their current market value. This strategy allows you to not only avoid ravages of higher rates, it also allows you to use these higher rates to your advantage by reinvesting proceeds from your maturing bonds in newly-issued bonds with higher coupon rates. Diversifying your bond portfolio among 2-year, 3-year, and 5-year Treasuries is a good start to a laddering strategy. As rates rise, you can then broaden ladder to include longer maturity bonds.
David Twibell is President and Chief Investment Officer of Flagship Capital Management, LLC, an investment advisory firm in Colorado Springs, Colorado. Flagship provides portfolio management services to high-net-worth individuals, corporations, and non-profit entities. For more information, please visit www.flagship-capital.com.
