The biggest financial news this month has been the Federal Reserve, which raised short-term interest rates by one-quarter of a percentage point on September 16. It might raise rates by another quarter point, maybe a half point, in coming months.
There’s been a lot of coverage of how rising rates affect home buyers and anybody else taking out a loan. Basically, loans cost more and costs go up, duh. That’s bad for consumers.
But rising rates also mean higher returns for investors, as long as you know where to look. A quarter-point hike may not sound like a lot. But we’re in a rising-rate environment, and it’s possible that interest rates might be resetting higher for the foreseeable future. That can add up, which means it might be time for investors to rotate a bit more money into the right bond funds.
There are different types of interest rates, based on the underlying securities that set them. They can be very different. US Treasury securities, for example, range from four weeks at the short end to 30 years at the long end. Most ordinary investors don’t hold bonds anymore. Instead, they own money-market funds that invest in short-term assets, and other kinds of mutual funds and ETFs with diversified holdings. This makes the investments liquid compared with bonds you’d hold until they fully mature.
Beware bonds?
Bonds and bond funds are more complicated than stocks, because there’s both a price and a yield, and they move in opposite directions. For simplicity, this discussion will focus on money-market funds. There are many guides to the broader world of bonds at sites such as Investopedia, Morningstar and every major brokerage.
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The return on money-market funds during the last decade has been low because interest rates have been relatively low. But that’s changing, as the following chart illustrates. It shows the yield on the 10-year Treasury note, which is set by markets, the short-term rate the Fed sets, and the yield or return on a typical money-market fund, using Fidelity’s main MMF as a proxy. (If you want to get into the weeds on the difference between rates and yields, here’s a good place to start.)