Bonds have been around ever since folks could utter, "Hey, can you lend me a buck?" But with interest rates at historic lows, investors should consider the probability of earning a positive return before buying their next bond investment. Low interest rates mean there is little cushion for declining bond prices when interest rates do rise. A look at the dynamics at play and what an investor should consider when investing in bonds.

1. most investors want to know not if interest rates will rise, but when they will rise.
bonds have been around ever since folks could utter, "hey, can you lend me a
buck?" a look at the chart shows interest rates are low in the context of history.
we are never, ever, ever getting back together...
Interest Rates are Very, Very, Very Low
1
1 mo 0.02%
6 mo 0.08%
1 yr 0.22%
2 yr 0.66%
5 yr 1.57%
10 yr 2.08%
30 yr 2.68%
march 3rd, 2015
us treasury
yields:
Board of Governors of the Federal Reserve System (US), 20-Year Treasury Constant Maturity Rate
[WGS20YR], retrieved from FRED, Federal Reserve Bank of St. Louis https://research.stlouisfed.org/
fred2/series/WGS20YR/, March 5, 2015.

2. you buy a $1,000 5 year us treasury bond with the 1.57% interest rate available in
the market today
year 1 interest payment of $15.70
5 year us treasury interest rates rise and yields go up the historical average
of 1.63%. a 5 year us treasury bond can now be bought yielding 3.20%
your bond is now worth $925.24
$925.24+$15.70 interest = $940.94
-5.906% loss on bond
don't take my word for it,
use an online bond calculator
to put in your assumptions about what is going to happen with interest rates
2
your poor coupon-clipping grandma...
An Example Using Historical Data
free-online-calculator-use.com

3. the problem: if you buy a bond mutual fund or exchanged traded fund (etf), the
option of holding your investment to maturity is not available. you can only sell your
bond investment at the market price.
! there is no "maturity date" for a mutual fund or etf, therefore, other investors'
purchases and redemptions influence the price of your investment.
! in the past, when interest rates rose and bond prices fell the bond's interest payments
offset the decline in the price of the bond and the investment still made money. the
offsetting interest rates were much higher than today's very low yields.
the solution: if you decide to have bonds be a part of your investment portfolio, buy
individual bonds that you can hold to maturity.
! if you buy a bond and hold it to maturity, you know what your return will be (the
interest rate on the bond).
! assuming the issuer of the bond does not go kaput before they pay your money back,
market changes in the price of the bond won't impact your return.
3
math class flashbacks...
Rising Interest Rates = Falling Bond Prices

4. central banks across europe have driven short-term interest rates below zero
(ouch!) to try to stimulate growth in the economy, which is in much worse shape
than the us economy. this is the first time in history for negative interest rates.
the 5 year german bund (the german equivalent of a 5 year us treasury) is
currently yielding -0.04%.
4
vacation in europe, but don't buy bonds there
What if Bond Interest Rates Fall Further?
you buy a $1,000 5 year us treasury with the 1.57% interest rate available in the
market today
5 year treasury interest rates
fall to 0.01%
your bond is worth $1,077.98
plus any interest payments
you have received
+7.80% bond price gain plus interest payments, which is your best case upside
scenario
free-online-calculator-use.com

5. why do investors buy bonds? they want
safe income and capital preservation. interest
rates have declined since the early 1980's and
will probably remain low for longer than
expected given the weak global economy. but
when interest rates do eventually rise, several
years of low interest payments may be wiped out
by bond price declines.
5
how much are you willing to risk for that 2% interest payment?
Final Thoughts and Takeaways
Board of Governors of the Federal Reserve System (US), retrieved
from FRED
! if you want to invest in bonds, buy individual bonds and hold them to maturity to
collect interest payments.
! do not buy bond mutual funds or exchange traded funds where principal declines
with increases in interest rates.
! consider your portfolio's allocation to fixed income investments and what return
and risk you can expect in a sideways or rising interest rate environment.