When is it safe to transition my investments from equities to bonds?
How do you determine when it is safe to move assets from equities to bonds given the prospect of rising interest rates?
Whether you want to take profits on your equities or lighten up your exposure to equities, in a rising interest rate environment you may want to consider shorter duration bonds. This reduces your sensitivity to movements and U.S. interest rates. You can take on more credit risk so you add some yield cushion to your portfolio. If you are investing in high yield bonds, you are already shortening duration versus investment grade corporate bonds, and you are increasing the yield cushion. You can also look for less correlated asset classes that also provide yield. This may include equity income type strategies or emerging market debt type strategies.
There are a number of different ETF solutions for investors to target rising interest rates. One might be on the credit side on the high yield space or a high yield bond ETF. On the opposite side of the spectrum is an interesting credit opportunity with short duration is an investment grade floating rate note.
If you think interest rates are headed up, you can protect yourself by investing in debt securities whose interest payments adjust regularly. Floating-rate funds invest in bank loans made to low-quality companies. The rates on these loans usually reset every 30 to 90 days at a few percentage points above a benchmark of short-term rates. Until the financial crisis struck, bank-loan funds had done a superior job of delivering above-average yields with minimal movements in their share prices. In 2008, the average bank-loan fund surrendered 30%, although the sector has rebounded strongly, gaining 42% on average in 2009 and 9% last year.
You have figured this one out already. It is not as much about your risk tolerance as it is the risk in the asset class itself. And that risk changes over time. In my opinion, the risk profile of bonds has increase since just a year ago. If rates rise, conventional bonds will decline. There are ways to hedge this risk or you could have some of your bond portfolio in floating rate bonds where the coupon/interest rises as rates rise.
If you think rates are going to rise and you are going to move into bonds (not recommending this), then accept less interest and stay in shorter maturities. This is because the longer the maturity, the bigger the price impact to rising rates.
Hope this helps and best of luck, Dan Stewart CFA®
Due to the potential of rising interest rates, it's important to have a balanced portfolio of both stock and bond funds. As you move closer to retirement, you can make your portfolio more conservative by increasing your bond allocation, but it's important to not tilt too heavily in case interest rates do rise. Fighting inflation is also important and stocks can help with that along with helping to grow and hpreserve your principal.
Normally you adjust your portfolio asset allocations (i.e. equities to bonds) in a slow fashion so that it doesn’t incur any huge capital gains, particularly in a taxable account. Unless you’re close to retire, expect to see a high interest rate (6 or 7%) in a safe investment (CDs, Savings) any time soon, or need some cash for an immediate project, I would not recommend a sudden change of cutting equities and moving to the bonds. Yes, interest may be on the rise, but it’s not going to be as high or rising fast as you may have hoped. Furthermore, when the inflation picks up, you will lose more purchasing power if you have a lopsided position in the bonds than if you have equities.
Sometimes a seemingly simply question can produce complex answers especially investing is based on a person’s time horizon, risk profiles, and tax bracket. Thus, to be truly helpful, it’s best to consult with a professional in person who may recommend more appropriate strategy that’s suitable to your particular needs. Best!
Are you asking when you should become more conservative? If so, understand that bonds are not risk free investments. Risk is a function of price-to-value relationship and one can make a solid argument that bonds right now are "riskier" than stocks. Before making a decision, I would spend some time understanding investment risk or consulting with an advisor.