Fed policy changes and your portfolio

If you’re wondering how changes in Federal Reserve policy may affect bond markets, Michael DiJoseph, CFA, of Vanguard Investment Strategy Group, offers his thoughts on what investors should or shouldn’t do with their portfolio.

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Amy Chain: I’m going to throw a question out there from Anton, who is asking us about something that I think is on the minds of many right now. How are we thinking about the Fed decisions and how that may or may not affect bond markets as interest rates perhaps change? Anybody want to tackle that one?

Michael DiJoseph: Well I’ll start with this. We’ve been talking a lot about a plan and the importance of having a plan. I would say that your plan should be very focused on you and your life and what happens in your life, and it should be durable for different market conditions—for rising rates, for falling rates—regardless of what the Fed does.

So for most people, we wouldn’t say to change anything about what they’re doing. Based on what the Federal Reserve is doing, it’s kind of having that written plan that allows you to have a little more discipline when you’re actually sticking to it and understanding, hey, you know, if something changed in your life, then maybe you kind of change course a little bit. But absent that, we would say that all else equal, we wouldn’t advise a change for most people just based on a Fed decision.

Amy Chain: And maybe we could spend a minute, as well, talking about the difference between sort of bond investing and investing in a bond fund and how interest rates maybe have a different impact. Mike, do you want to tackle that one?

Michael DiJoseph: Sure, yes. So, actually, when you’re investing in a bond fund, you have a portfolio of a bunch of different bonds, so there’s diversification. And what happens is, so let’s say the Federal Reserve raises rates, and the bond market rates follow, which you know there’s not a perfect relationship there. But what will happen is that fund is now buying those new bonds at a higher yield, right? So in traditional economic theory as interest rates go up, bond prices go down. So let’s say you buy an individual bond, and the rate goes up, the price is going to down. Now it really doesn’t matter that much, unless you actually sell it. Right, you’ll still get your principal back, all else equal at the end. But when you have a bond fund, rising rates can actually help a long-term investor because they’re actually buying new bonds at higher rates, so you’re getting a higher return from those bonds.

Important information

All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.

Investments in bonds are subject to interest rate, credit, and inflation risk. Past performance is no guarantee of future returns.

This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.