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Interest rates are rising (or falling): What should I do with my bond investments?

Question: What should I do about bond market news?

Answer: There is rarely a lack of breaking news related to Canadian, U.S. and global bond markets. Interest rates are expected to rise or fall. Yields are heading up or down. Spreads are narrowing or widening, and curves are inverting or remaining consistent. The analyses and projections can leave an investor’s head spinning!

If you want the shortest possible answer to how we typically recommend you respond to varied bond market news, it is this: Don’t.

We realize that the news seems important. As it relates to our evidence-based insights on how bond markets operate, it is important. It helps us ensure that market theory and market realities coincide as closely as possible over time.

But as it relates to your immediate fixed income holdings we don’t recommend reacting to breaking news. A recent Dimensional Fund Advisors paper, “Considering Central Bank Influence on Yields,” helps us understand why this is so. Analyzing the relationship between U.S. Federal Reserve policies on short-term interest rates versus wider, long-term bond market rates, the authors found:

Recently [in September 2015], some market prognosticators believed that the Fed was going to begin raising the federal funds target rate. However, what actually happened reinforced how difficult it is to accurately forecast when a Fed tightening cycle will occur or what its effects may be.

The paper continues:

History shows that short- and long-term rates do not move in lockstep. There have been periods when the Fed aggressively lifted the fed funds target rate—the short-term rate controlled by the central bank—while longer-term rates did not change or “stubbornly” declined.

In short, even when an outcome is widely predicted by the pundits – such as a central bank raising or lowering interest rates, it’s never a sure bet that it will actually occur as expected. Even if it does occur, the markets may or may not respond as expected to the news.

Instead of attempting to read the bond market tea leaves, our advice to fixed income investors is going to seem tediously repetitive, because it’s what we almost always say to almost all investors: (1) Create a customized plan according to your own goals and risk tolerances. (2) Build a portfolio that reflects that plan, including appropriate allocations to low-cost, efficiently managed fixed income holdings. (3) Maintain your portfolio over time, adjusting it only if your personal circumstances call for a change.

This disciplined approach to fixed income investing does not guarantee success. But the evidence from Dimensional’s report and many others like it strengthens our belief that it offers the greatest odds of achieving the outcomes you have in mind.