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How much do Bonds and TIPS get affected by interest rate increase

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  • How much do Bonds and TIPS get affected by interest rate increase

    I see everyone stating that bond value decreases with interest in increase rates but to date, I am not able to understand by how much. For example, in a bear market, I understand that I may loose > 20% in stocks. Is there any such way o quantifying the possible loss in bonds.

    Hypothetically, Lets say, the interest rates increase by 1% over a year from now -Approximately, by how much will 10k in short term / intermediate term/ long term bond get affected, all other things being equal [high quality bonds].

    And do TIPS fare any better in the scenario of increasing interest rates?

    Thanks everyone for the input.

     

     

  • #2
    First, if you are holding individual bonds vs. a bond fund or ETF, and you hold to maturity, you will get your full principal back plus the interest.  I'm assuming the bond isn't called nor the entity goes bankrupt.

    Bond Prices and Yields work in an inverse fashion.  If you bought a 10-year Treasury bond for 2.00% at Par (no discount or premium) back in January, that bond is now worth more than you paid for it as the 10-year Treasury rates have dropped.  If rates had risen, your bond would be worth less then you paid for it.  As long as you are holding it to maturity though, neither of those matters.  Usually, individual corp and muni bonds have a $5k minimum.  I'm not sure on Treasury bonds.

    Bond funds and ETFs work a bit differently because they may hold 1000s of individual bonds so a bit more goes into the pricing.  This website had some good info on that -- http://www.etf.com/etf-education-center/how-do-bond-etfs-work .  New bonds are constantly being purchased from those that matured or were called.  If the bond holds medium to long-term maturities I would expect its pricing to have moved in a positive direction recently as those bonds would be more valuable.  I do hold 3 different bond ETFs.

    There are other risk considerations, but didn't want to write a book at this point.  :O)

    cd :O)
    Yet those who wait for the LORD Will gain new strength; They will mount up with wings like eagles, They will run and not get tired, They will walk and not become weary. -- Isaiah 40:31

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    • #3
      Longer maturities are more subject to rate risk in general. Also as things are closer to the zero bound smaller moves have larger impacts as it is not linear. One of the things to research is something called average and effective duration. For example, if you find a bond fund with an average duration of 13.2 and rates go up by 1%, you can expect a ballpark loss of about 13.2%. Its a back of the envelope kind of thing and not an exact figure, but helps you gauge risk in a rising rate environment. Of course you can just hold to maturity and get all the principal plus interest.

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      • #4
        Thanks ChrisCD and Zaphod. Just to make sure I understand correctly - is the principal only guaranteed for an individual bond and NOT for a bond fund. Thanks again.

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        • #5
          yes thats correct.

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