For seniors who rely on interest income, a recent rise in interest rates is good news. But for others, heavily invested in bonds or bond mutual funds, it's not so good.
Rising interest rates hurt the value of already-issued bonds. That's because newly issued bonds pay a higher interest rate, making them more attractive to investors.
And rates have been on the rise. The yield on the 10-year U.S. Treasury bond — a benchmark for many kinds of interest rates — has risen from 1.63 percent in May to 2.75 percent last month.
"Bond values are beginning to fall," said Tom Murphy, certified financial planner. "Anyone who owns a bond yielding current low interest rates is going to have a hard time selling that bond when rates move up simply because everyone always wants as much interest as possible."
So if you've been invested in bonds, how should you adapt?
"We would caution against abandoning bond allocations altogether," said Mary Ellen Stanek of Robert W. Baird Co., a wealth management firm.
She does recommend, however, that seniors think strategically about their portfolios.
RETURNS VS. RISK: Alternative investments, such as stocks, may offer higher potential returns than bonds, Stanek said, but they also come with higher risk.
Bonds aren't returning much right now, but they provide good diversification, she said. They also offer relative safety.
"Most seniors can't/shouldn't/don't want to take on the volatility of an all-equity portfolio and, therefore, maintain at least some exposure to bonds," Stanek said. "Furthermore, many seniors rely on the income from their bonds to meet living expenses, so bonds typically play a key role in their portfolios."
BONDS VS. FUNDS: Murphy said investors should avoid bond mutual funds and stick with individual bonds.
"If you want to stay in bonds, buy individual bonds and plan to keep them until they mature," he said.
With an individual bond, you can choose to hold the bond until maturity and recoup at least the face value, no matter how much the price fluctuates in between, he said.
If you do invest in a bond fund, Stanek said, "look for funds with below-average expense ratios to keep costs in check."
SHORT VS. LONG: Stanek said investors should stick with short- to intermediate-term high-quality bonds. That's because longer-term bonds are more sensitive to rising interest rates than shorter-term bonds.
Going with shorter-term bonds does come at a price.
"These bonds typically pay less than longer-term bonds and riskier bonds, so their low yields may not be right for investors with longer time frames," said Rick Salmeron, a certified financial planner.
One strategy is to build a "ladder" of bonds that mature at different intervals, such as at three months, six months and 12 months, Salmeron said.