Retirees rely on bonds for stable income generation and lowering the risk of their investment portfolios. However, with the Federal Reserve eyeing multiple interest rate hikes this year, some are worried about the negative consequences of a tighter monetary policy on their retirement portfolios.
Federal Reserve Chairman Jerome Powell projected a series of rate hikes this year, along with reduced pandemic-era accommodative supports from the central bank, to combat rising inflation, which has hit 7% year-over-year in December, its fastest pace since 1982, CNBC reports.
However, with a higher rate outlook, bond investors are worried, since bond prices typically have an inverse relationship with rates, so higher rates mean lower bond values, a situation otherwise known as interest rate risk.
For instance, for a 10-year $1,000 bond paying a 3% coupon, if market interest rates rise to 4% in one year, the asset will still pay 3%, but the bond’s value may drop to $925. This fall-off in price is expected since new bonds would be issued with a more attractive 4% coupon, so older bonds with a lower coupon become less attractive, so buyers would demand a discounted price.
Certified financial planner Brad Lineberger, president of Carlsbad, California-based Seaside Wealth Management, warned that with higher yields, investors will sell current bonds for the higher-paying ones, which would also cause overall prices to fall off with the new supply of old debt hitting the marketplace.
Additionally, duration matters. The longer a bond’s duration, the more sensitive the debt security will be to interest rates or a steeper fall-off in its price.
Paul Winter, a CFP and owner of Five Seasons Financial Planning in Salt Lake City, argued that investors worried about rate risk can consider shorter-duration bonds or bond funds to limit pullback.
“Also, bonds with higher coupon rates and lower credit quality tend to be less sensitive to higher interest rates, other factors being equal,” Winter told CNBC.
One strategy that ETF investors can consider to better manage risk and generate some income along the way is using something like the Nationwide Nasdaq-100 Risk-Managed Income ETF (NYSE Arca: NUSI), which seeks current income with a measure of downside protection.
NUSI follows a rules-based options trading strategy that seeks to produce high income using the Nasdaq-100 Index, an index of the 100 largest non-financial stocks on the Nasdaq exchange. The ETF may potentially complement traditional equity and fixed income allocations or function as a possible hedge for investors.
The Nationwide Risk-Managed Income ETF establishes a collar strategy to generate monthly income. Collar strategies involve holding shares of the underlying stock while at the same time buying protective put options and writing calls for the same security. A put option gives its owner the right but not the obligation to sell the underlying asset at a specified price and on a specified date. A call option gives its owner the right but not the obligation to buy that asset instead.
For more news, information, and strategy, visit the Retirement Income Channel.
This article was prepared as part of Nationwide’s paid sponsorship of ETF Trends.
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Nasdaq-100® Index: A rules-based, market capitalization-weighted index of the 100 largest, most actively traded U.S companies listed on the Nasdaq stock exchange.
Duration – a measure of the sensitivity of the price of a bond or other debt instrument to a change in interest rates. A bond’s duration is easily confused with its term or time to maturity because certain types of duration measurements are also calculated in years.
Coupon – the annual interest rate paid on a bond, expressed as a percentage of the face value and paid from issue date until maturity.
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