Impact of interest rates on bond funds

Historically, the equity/bond strategy of balancing growth potential and protection has worked well for many investors, largely due to bond fund performance during the decreasing interest rate environment over the past 30 years. Since decreasing interest rates generally result in higher bond prices, the recent past has been a good period for many bond funds. The 10-year U.S. Treasury yield, a key indicator of the general level of interest rates in the U.S., reached an all-time high of 15.84% on September 30, 1981. Since then, rates have fallen steadily, with the 10-year Treasury hitting an all-time low of 1.43% on July 25, 2012 – a decrease of over 14 percentage points in slightly more than 30 years. The dramatic decrease in interest rates is largely why bond funds have been very effective at helping to manage risk in a balanced portfolio.

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1 10-Year U.S. Treasury: Federal Reserve.

2 Barclays Capital U.S. Aggregate Bond Index (Barclays Index), Bloomberg.

However, interest rates have little room to go down further, so bond funds will likely not be as effective in protecting a balanced portfolio of the future. In just the short period from May to August 2013, rising interest rates hit bond funds; the Barclays Capital U.S. Aggregate Bond Index (Barclays Index) declined 3.67% from May 1, 2013 to August 31, 2013.

If interest rates continue to climb, an IVA may help investors achieve a more balanced approach.

Plus, investors may be unaware that bond funds can lose money. In a 2012 U.S. Financial Capability study by the FINRA Investor Education Foundation, 72% of adult Americans did not answer correctly or did not know the impact interest rates have on bond prices. If interest rates continue to climb, an IVA may help investors achieve a more balanced approach of growth potential with a level of protection against down markets.

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