Evaluate and Manage Your Interest-Rate Risk
Understanding Interest Rate Risk
The threat of lower bond prices due to rising interest rates is called "interest rate risk." This risk cannot be eliminated, but it can be managed. Consider:
- Diversifying your bond fund portfolio with funds that hold higher-yielding securities that are typically less interest rate-sensitive than Treasuries, such as corporate bonds or mortgage-backed securities.
- Focusing on shorter-duration funds for less volatility, or money market funds for capital preservation.
Duration, which is an indication of the relative sensitivity of a security's market value to changes in interest rates, is based upon the aggregate of the present value of all principal and interest payments to be received, discounted at the current market rate of interest and expressed in years. The longer the weighted average duration of the fund's portfolio, the more sensitive its market value is to interest rate fluctuations. Duration is different from maturity in that it attempts to measure the interest rate sensitivity of a security, as opposed to its expected final maturity.
As with all investments, there are risks of fluctuating prices, uncertainty of dividends, rates of return and yields. Current and future holdings are subject to market risk and will fluctuate in value.
Diversification does not assure a profit nor does it protect against loss of principal.