Most investors don't understand the connection between rising interest rates and their portfolios. As sad as that may be, it's also a golden opportunity for advisers.
If the results of a new investor survey are any indication, financial advisers will have their work cut out for them when interest rates start rising and bond prices start falling.
In a survey of U.S. investors, Edward Jones found that two-thirds of the respondents don't understand how rising interest rates will affect their investment portfolios. Twenty-four percent of those surveyed admitted they “feel completely in the dark about the potential effects.”
Financial advisers said such findings are not surprising and not a major issue — as long as the investor is working with a competent adviser.
“Our clients pay us to worry about such things as rising rates, so it doesn't really matter if they have a grasp of it or not,” said David Hulstrom, president of Financial Architects LLC.
Sheryl Garrett, founder of The Garrett Planning Network Inc., said the survey findings fall in line with what she sees when working with her clients.
“When I have annual meetings with clients I usually start off by going over the differences between stocks and bonds,” she said. “I'm not surprised by the survey because most of my clients are not interested in that stuff, and that's why they're paying someone else to manage their portfolios and their financial life.”
Even if some advisers are confident that they will be adding value in a rising rate environment, the survey findings should represent a general wake-up call.
“I'm surprised that there are even a third of investors who say they understand the impacts of rising interest rates, because bond math is confusing,” said J. Brent Burns, president of Asset Dedication LLC.
“Unless you fully understand the inverse nature of dropping rates and rising bond prices, you don't really understand what's going to happen when rates start rising,” he added. “That fact was clear in May when bond funds saw big losses after some comments by the Fed triggered a slight bump up in rates.”
The yield on the benchmark 10-year Treasury bond has gained a full percentage point since mid-May, mostly driven by a market bracing for a reduction in the pace of the Federal Reserve's five-year quantitative-easing program.
Beginning next month, the Fed is expected to start tapering its pace of monthly Treasury bond purchases, currently at $85 billion per month.
It could be a year or more before the Fed is no longer buying Treasury bonds. From there, the Fed could start further tightening by increasing the overnight lending rate, currently held down to near zero.
In the fixed-income world, this simplified storyline adds up to a lot of pressure on bond prices, and bond mutual funds are considered potential losers.
“If anyone has been investing in bond funds for any length of time, it has been a great ride, but it's time to hop off and move into individual bonds or some kind of structure that will protect portfolios when rates start rising,” Mr. Burns said.
Tom Kersting, an investment strategist at Edward Jones, said advisers should not take the outlook for interest rates lightly.
“We've been communicating both with financial advisers and directly to investors, and we think the best way to prepare is to make sure investors have a properly diversified and laddered bond portfolio,” he said. “We've been quite vigilant about getting the message out that portfolios need to be prepared for this.”
