Small investors should beware of rising interest rates, a regulatory group warned Thursday.
The Financial Industry Regulatory Authority issued an “investor alert” warning individuals that their fixed-income holdings could lose value if interest rates rise.
With interest rates hovering near record lows, a wide range of experts worry that small investors are not prepared – financially or emotionally – for the eventual likelihood that rates will rise.
In general, an increase in the rates being paid on newly issued bonds, such as popular U.S. Treasury securities, erodes the value of older bonds.
If a newly issued bond pays a 3% interest rate, it makes sense that an older security yielding 2% is not worth as much. In other words, if an investor needed so sell a bond or exit a bond mutual fund, they could suffer an unexpected loss.
But any fall in the value of their fixed-income holdings could jar small investors who have huddled into their supposed safety in recent years and don’t understand the potential risks.
The warning by FINRA, a Wall Street trade group that also polices the markets, focuses on a market gauge known as “duration,” which attempts to forecast the potential impact of rate changes on a portfolio.
In general, according to the alert, a bond mutual fund with a 10-year duration will decrease in value by 10% if interest rates rise 1%.
“With interest rates hovering near all-time lows, investors should make sure they know their duration numbers,” Gerri Walsh, FINRA vice president of Investor Education, said in a statement. “Whether investors own individual bonds or bond funds, they need to understand that outstanding bonds with a low interest rate and high duration may experience significant price drops if interest rates rise.”
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