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Risk and reward in bonds and CDs

By Sheyna Steiner · Bankrate.com
Wednesday, August 13, 2014
Posted: 6 am ET

© Ollyy/Shutterstock.comThe Federal Reserve looks to be on course to hike interest rates sometime next year. Like closing your eyes and waiting for the punch you know is coming, many bond investors have dreaded and feared the day that rates increase. The prices of bonds move inversely to rates so when rates go up, the prices of existing bonds will drop.

But bonds aren't the only investments that will be adversely affected. A rate hike also could impact the owners of certificates of deposit. Savers will be stuck with low-yielding investments relative to those that become available as CD rates increase with those set by the Fed.

In order to mitigate interest rate risk and earn better returns, investors have been flocking to ultrashort-term bond funds, a recent story on the Wall Street Journal website reported, "The Safety and the Risk in Ultrashort Bond Funds."

By scaling back in duration,a measure of interest rate sensitivity, investors hope to avoid the volatility anticipated in longer-term bond funds when the Fed raises rates. The values of longer-term bonds will take a hit as rates go up and that hit will increase with maturity.

Unlike investors who hold individual bonds to maturity and are nearly assured of recouping their investment when the bond comes due, bond fund investors are subject to the tumult introduced by fund managers and their fellow investors. In other words, losing money is possible in bond funds.

A loss in an ultrashort-term bond fund is possible as well, though to a lesser degree. The average duration of bonds in the ultrashort-term bond funds category averages 0.6 years, according to the fund research company, Morningstar. The duration of 0.6 years indicates that very short-term bonds have less interest rate sensitivity than their long-term cousins, with an average duration of 8.6 years.

The average one-year return in the ultrashort bond category is about 0.78 percent, Morningstar reports. For CD investors, the boost in yield may not be worth the steep increase in risk. According to Bankrate's weekly survey, the average one-year CD yield is 0.24 percent.

For savers willing to climb up the risk ladder, there are a few unusual investments that can yield fat returns.

Would you take on the added risk of bond funds for the extra yield?

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***
Senior investing reporter Sheyna Steiner is a co-author of "Future Millionaires' Guidebook," an e-book written by Bankrate editors and reporters. It's available at all the major e-book retailers.

 

 

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7 Comments
Mark Ginsburg
August 15, 2014 at 7:43 am

This is also addressed to Bruce Witte. Consider making your comments in lower case, it makes it easier to read your comments.

Mark Ginsburg
August 15, 2014 at 7:41 am

This is addressed to Bruce Witte. We are still bailing out the banks by letting them borrow money from the Federal Reserve at 0% to 0.025%. This is being done so the banks will have cheap money to lend to individuals and businesses to invest in the economy. Instead of lending that money (investing in the economy) they are investing it in mainly long term treasuries(the 10 year U.S. Treasury note is currently paying approximately 2.4%. The banks use this spread (approximately 2.4% to 2.15% to increase their capital. So if you think the end of TARP was the end of the taxpayer bailout, you're quite mistaken.

BRUCE WITTE
August 14, 2014 at 8:39 pm

THE GOVERNMANT SHOULD REVERT BACK TO MAKING THE BANKS PAY A REALISTIC INTEREST RATE WHEN THEY BORROW MONEY. WHEN I WENT TO SCHOOL WE WERE TAUGHT THAT WHEN WE PUT MONEY INTO THE SAVINGS BANKS THE BANKS TOOK OUR MONEY AND INVEST THE MONEY AND IN RETURN THEY PAID US A PERCENTAGE. TODAY THE BANKS GET ALL THE MONEY THEY WANT FROM OUR GOVERNMENT WITHOUT HAVING TO PAY ANY INTEREST..FREE MONEY. MAY I REMIND THE GOOD CITIZENS OF THE UNITED STATES, THAT IT WAS THE BANKS WHO GOT US INTO THE TROUBLE WE ARE IN TODAY. FOR SOME REASON OUR GOVERNMENT FEELS THAT THE BANKS SHOULD BE REWARDED ?? PERHAPS IF SOME OF THE BANKS HAD FOLDED, MAYBE THE REMAINING WOULD BE RELUCTANT TO INDISCRIMINATELY LOAN MONEY IN THE FUTURE. OUR GAVERNMENT WAS ALSO RESPONSIBILE FOR GIVING THE LARGEST BANKS IN THIS COUNTRY BILLIONS OF OUR DOLLARS WHEN THEY BEGAN TO FALTER AND WHAT DID THESE BANKS DO WITH THIS MONEY? [AS PRINTED IN THE LARGEST NEWS PAPERS IN THE COUNTRY], THEY GAVE THEMSELVES BONUSES!!!!!
OUR GOVERNMENT HAS MADE MANY MISTAKES AND IT MUST STOP.
CORRECT ME IF I AM WRONG, BUT WHEN WE WERE IN WORLD WAR ONE & TWO, WHEN THE GOVERNMENT NEEDED MONEY THEY SOLD WAR BONDS. THEY DIDN'T GO INTO THE BASEMENT AND PRINT MONEY..WHICH DID NOTHING MORE THEN DEVALUE THE DOLLAR TO A CRITICAL POINT IN OUR ENCONOMY. THE BONDS PROVIDE THE CITIZENS WITH AN OPPORTUNITY TO INVEST WITH LITTLE RISK, AND THEGOVERNMENT WITH MONEY TO FIGHT THE WAR.
TODAY OUR CITIZENS RECEIVE ALMOST NOTHING FROM THE BANKS WE BAILED OUT. OUR RETIRED CITIZENS HAVE LITTLE CHANCE TO BE SELF-SUFFICIENT. IT IS TERRIBLE HOW THE GOVERNMENT HAS CARED FOR THE RICHEST BANK EXECUTIVES AND LEFT THE AVERAGE CITIZEN TO FEND FOR THEMSELVES WITH ANY SUPPORT FROM THEIR GOVENMENT. PLEASE REMEMBER THE MONEY OUR GOVERMENT GAVE TO THE BANKS CAME FROM THE MONEY WE PAID IN TAXES. CLEARLY THIS CONCEPT IS VERY WRONG AND UNFAIR TO THE AMERICAN TAX PAYER.
I SINCERELY HOPE THAT MY EFFORT BY WRITING THIS INFORMATION WILL IN SOME WAY BE HELPFUL ? PLEASE REPLY.........

Mark Shuffelbottom
August 14, 2014 at 5:57 pm

Another BS article on how take advantage of this wonderful economy we are experiencing. The reality is our stock market is rising because the Fed is pumping Billions into the market like a weightlifter on Steroids. We continue to raise the deficit to 18 Trillion while our corrupt government continues to manipulate the market mostly because of the elections in Nov. You can bet Obummer is telling Yellon of the Fed to keep it up until Nov because the Obummer has to keep the Senate. Oh let not forget Obummer Care which is the nail on the coffin. Our true economic indicators tell a different story. No jobs or should I say lots of low wage part time jobs. GDP & GNP at an all time low. Oh, I forgot that GDP was at 4% last quarter. NOT. That is a phoney lie too just like the 1st quarter correction from 2% to -3%. Production down and consumer debt up. Ya Ya Ya. We must also not forget demographics in economics. The wonderful baby boomers who created alot of this mess for us younger folks like generation x have to pay for all their greed and bad decisions. They had everything handed to them only to piss it away and now the younger generations are stuck with nothing. How sad. The worst is yet to come and I am afraid that it will be much worse than before. Our government has been manipulating the system for a long time but time is running out. Also, remember that many companies are using buyback strategies to increase the value of their stocks even though production, sales, and employment are down. Cisco announced a 6000 employee layoff.

As for the the world economy it in bad shape which concerns me even more especially with China and Russia. Russia is in the process of not using or currency and evenually our dollar will not be the world curreny anymore. Let politicians BS you and tell lies but numbers speak louder than words.

How many people are on welfare? 50 million collect whcih means that their dependants are on it too. That computes to about 100 million or 33%. One third in poverty and we have 20 million illlegals along with 50 thousand so called refugees coming in. How do we support them. The solution is we feed, medicate, and cloth them. Then we send them home to their families. This is another Obummer scam which he created to get more illegals in the country. MORE VOTES. This could be the end of a geat nation.
HOW AFRAID I AM.

Terrell
August 14, 2014 at 5:13 pm

This the same song we've been hearing for the last 4 years. I'll believe the interest rates are going up when I see it.
As for current rates...my credit union is paying 2% for a 5-year CD. Can't touch that at any bank!

Dorothy Jones
August 14, 2014 at 1:41 pm

Where can you cash Series E Bonds. Federal Credit Unions say they can't cash them and other banks won't cash them without paying a fee (IF you don't have an account with them)?

Mark Ginsburg
August 14, 2014 at 6:49 am

It appears that Bankrate.com is providing a service for the large banks who advertise on your site. If you want to provide a better service to your customers, i.e., CD investors, you would include CD and Money Market Account rates of smaller banks and credit unions who are not members of the Federal Reserve. Just be sure your bank or credit union carries insurance that is guaranteed by the Full Faith and Credit of The United States. By that I mean, make sure your deposits are FDIC insured. Credit Unions can also provide guaranteed insurance through another federal agency. The large brick and mortar banks are members of the Federal Reserve and can currently borrow from the Federal Reserve at 0.00% to 0.25%, so they don't need your money. Every once in a while, these large banks will offer higher rates (this is their bait) to get you to open an account with them. They realize that when someone opens an account with them, the bank is likely to have that account for a very long time. After the initial higher rate expires you are given a much lower rate. Most of the smaller institutions offer higher rates. Also, the internet banks offer higher rates because they don't have the expenses of brick and mortar banks. I've heard that people are afraid of internet banks because they might get hacked. They don't realize that brick and mortar banks are also subject to being hacked.
My best advice is to do your homework.

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