Are Higher Rates Ahead?

03/18/2013 8:30 am EST

Focus: MARKETS

Ed Finn

Editor and President, Barron's

Early 2013 has been tough for many bondholders, and Ed Finn thinks that the outlook for rates will be much different in the coming years.

I’m talking with Ed Finn of Barron’s today, and our topic is the bond market and interest rates. So, Ed, what do you think about what’s going on with the bond market? It hasn’t been so great lately.

No, it hasn’t, and I’m afraid interest rates are going to start to move up. I think the economy can probably move up 3% this year—which is very bullish, but that’s what I think—and maybe 3.5% next year. And if that happens, you’re going to see interest rates continue to inch up.

On the ten-year bond, I don’t think they’re going to shoot up, but they could go up a percentage point, which would be a more natural state of events.

The way things have been lately, the Fed has been holding artificially low to try to get the economy to heal. Well, it’s healed, and I think that period’s over. To the savers, and to other people, they’re going to be happy to get higher interest rates, and I think that’s one reason you could see some more money move out of the bond market and into dividend-paying stocks—which aren’t bonds, but they do produce a nice return.

What do you think rates could possibly go up to? Do you have a forecast?

Well, on the ten-year, over the next two years I think you could see them move up about a point. You might see them go up two points. So that puts interest rates somewhere about 3%. I think even if things are wonderful, they won’t go above 4%. So you don’t have hyperinflation to worry about, but you do have a turn in the market, and that’s one of the things we’re all keeping an eye on.

Well, would you suggest that individual investors continue to buy bonds, or at least have a certain percentage of their portfolio in the bond market?

I do, because although I think rates are going up, a lot of people thought that two or three years ago, and rates didn’t go up, so it was good to have bonds.

Also, bonds are very important. I mean, they’re a good balance to our portfolio, as in a boat or something. So I think what people might want to have is 10% or 20% in bonds, whereas in normal times, you might have 30% or 40% in bonds.

You might want to open up the amount you have in stocks, including dividend-paying stocks in the US, but also look at some funds or ETFs in emerging markets in other developments, or maybe sector funds in the US. I think a variety of things, but I think you want to lighten up on bonds, and to the degree you hold them, keep the maturity short.

OK, now it’s tough for a lot of individual investors to plunk down all that money to buy a bond, so what about bond funds for them?

Bond funds are good, but then again, when rates go up, a lot of people pull their money, so you’ve got a problem. So you don’t want to overdo it with bond funds. It’s not a bad way to go, but if you can just have a few dependable bonds, Treasuries, or whatever, I don’t think you need diversification quite as much as you do in the stock market.

In terms of dividends and paying stocks, let’s talk about REITs a little bit. We’ve had a real influx in new IPOs within the REIT market now. What do you think about those for individual investors?

I think REITs can be great, but they do require homework. You know, you can either go through a fund that invests in REITs, or you can do your homework. They’re not simple, but they do provide that nice yield, which is why they’re so popular and you’re seeing more conversions to that. Also, the real estate backing REITs is improving, and that can help a lot.

Yeah, we’ve seen a lot of REITs that have pretty outrageous yields, even now, and that’s a little scary for many investors. But then a lot of people will flock to those just because the yield is so good.

I’d be a little careful of that, because you know the old saying, if a deal looks too good to be true, it probably is. So you do have to watch out on the very high yields, and do your homework. Read the prospectus.

Related Reading:

5 More Reasons We Favor Bond Funds

Central Bankers' Hot Air Shortage

How Buyer's Remorse at the Fed Impacts You and Your Investments

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