Newspaper article St Louis Post-Dispatch (MO)

Bond Investors Wait for the Next Blow from Interest Rates

Newspaper article St Louis Post-Dispatch (MO)

Bond Investors Wait for the Next Blow from Interest Rates

Article excerpt

If you've been socking your money away in bond funds, now is nail-biting time.

Interest rates are heading up, and as they rise bond prices do a belly flop, because interest rates affect the sale price of bonds.

So, it's a good time to look at what you're risking if the market catches the inflation willies and sends interest rates up even higher.

The longer the term of your bond or bond fund, the more you gain when rates drop and the more you lose when rates rise.

Think of yourself as sitting on a tree limb. If you're sitting next to the tree trunk, you're holding short-term bonds. The winds of inflation can howl, but you won't shake very much.

The longer the length of your bond, the farther out on the limb you sit. If you're holding 30-year bonds, or long-term zero coupons, you're sitting way out on the flimsy tip of the branch.

There the interest-rate winds can give you a pretty scary ride.

A 1 percent rise in the rates will send the sale price of the 30-year bond down 12 percent. A 1 percent rate drop will send the price up 15 percent.

The price swaying is much gentler on the short end. On a one-year bond, for instance, a 1 percent interest-rate rise or fall will change the price only 1 percent. (See the chart.)

People crawl out to the end of the interest-rate branches because the fruit there is juicier. The interest yield on a 30-year Treasury bond, for instance, is now 6.8 percent, compared with 3.6 percent for a 3-month Treasury bill.

That interest yield, of course, cushions any price drops and sweetens any gains. If the bond price drops 6 percent, and the interest yield is 6 percent, then you break even.

Of course, none of this matters if you hold a bond to maturity. You'll get regular interest until the due date, then you'll get the face amount of the bond.

For instance, my daughter's college fund is in a zero coupon bond, and I'm happy to keep it there. No matter what happens with interest rates, it will give her $38,000 in 2001. That might cover a year's tuition by then. …

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