Interest rates are not lobsters:They won't sit at the bottom
forever. Either growth or inflation will pick up and the Federal
Reserve will be forced to reverse course and raise the discount
So, how do you ready your portfolios for the inevitable?
If you're anticipating a prolonged increase in interest rates,
avoid longer dated debt in favor of shorter-term securities,
especially if fixed income is a big part of your portfolio. That's
because as the duration of your fixed-income portfolio increases,
each hike in interest rates will affect long-dated bond prices much
more than prices of short-term paper.
Also, consider using the traditional bond ladder strategy
whereby several shorter-term securities replace a longer-term
security. For example, instead of locking in a low interest rate
with a 5-year bond, spread exposure over five years.
That means that each year a rung of the ladder matures, at which
point you can build a new rung with a note that will expire in five
The benefits are twofold:For one, instead of being constantly
stuck earning less than the prevailing interest rate, the regular
maturities allow cash to be reinvested at higher rates. In
addition, the strategy increases the probability of realizing price
appreciation on a retracement as interest rates advance.
If you prefer to avoid the hassle of a bond ladder strategy,
consider one of the following floating rate ETFs which would help
prevent you from getting locked into low-yielding securities:the
SPDR Barclays Capital Investment Grade Floating Rate ETF
(NYSEArca:FLRN), the iShares Floating Rate Note Index Fund
(NYSEArca:FLOT) and the Market Vectors Investment Grade Floating
Rate ETF (NYSEArca:FLTR).
A couple weeks back I wrote a blog about PIMCO's 25+ Year Zero
Coupon U.S. Treasury ETF (NYSEArca: ZROZ), which was up 75 percent
over a one-year period and was the best-performing ETF of 2011.
ZROZ was the best performing ETF because it maxes-out on
duration, which is exactly what you want to hold when interest
rates are falling.
But if you're confident that interest rates are headed upward,
consider owning PowerShares DB 3X Short 25+ Year Treasury Bond ETN
(NYSEArca:SBND), the ETN that attempts to do the opposite of ZROZ;
namely, to sell duration short as much as possible. However,
leveraged products contain their own set of pitfalls so be sure you
know what you're getting into, as my colleagues Devin Riley and Ana
Kostioukova have written about.
Don't forget to check IndexUniverse.com's ETF Data
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