Sure, interest rates remain low as the Fed keeps its easy money policies in force.
However, the increased talk of “tapering” should alert investors to the fact that central bank policies can’t stay loose forever — and if interest rates rise either because of a hard increase to the Fed funds rate or simply because that’s what market sentiment dictates, it can take a bite out of your long-term bond investments over the next year.
Thanks to the inverse relationship between price and yield, increasing interest rates will mean you lose value in bond funds. Consider that from May to early July, when rates on the 10-year T-Note rose about 1%, the iShares 20+ Year Treasury Bond ETF (TLT) lost about 15%. That’s because 95% of the holdings are more than 25 years in duration, and the longer the duration, the more susceptible bonds are to interest rate increases.
If you own actual bonds and hold to maturity you don’t need to worry about this; instead of rolling your money over into new long-term bonds, you’re simply holding your investment and collecting the income.
However, many investors prefer to invest in bond funds for the diversification and ease of trading — and the fact that your manager will be buying new long-term bonds in 2014 right before interest rates rise will mean you could take a significant haircut on the total value of your investment.