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Investing Specialists

Your Plan for Rising Interest Rates

From shunning bonds to staying the course, our readers discuss what they're doing to prepare for rate hikes.

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Morningstar contributing writer John Waggoner recently wrote an article in which he outlines five things investors could do to prepare for rising interest rates

This week, we asked what you are doing (if anything) to prepare for rising rates. 
Some are still deciding on the best course. Boomerguy, for instance, is still pondering the decision: "Reviewing my bond fund holdings. May eliminate funds altogether or may just ride it out. Hate losing principal, though, in what is in reality just a holding pattern for cash." 

Others seemed to fall into a few main camps. Many respondents said they had a long-term portfolio plan that made sense, and they don't plan to make any changes to it. But others said they thought it made sense to make some shifts at the margins of their portfolios, including shortening up the duration of their bond fund holdings and increasing their cash stake. Other readers described some larger portfolio shifts they had made (or plan to make) in anticipation of rising rates. 

Below is a summary of what our readers had to say. To read the full discussion and weigh in yourself, please click here

I'm Staying the Course
Many readers feel they have an asset allocation plan that makes sense for their needs, and interest-rate moves won't tempt them to sway from it. 

"I invest for the long term and never try to out-guess the market," said ColonelDan. "Other than recently upping my stock allocation from 50% to 60% by folding my   Vanguard Wellesley Income (VWINX) holdings into  Vanguard Wellington (VWELX), I'll stay the course."

Matthewriggio agrees: "I stick to my long-term plan by keeping asset allocations in check based on my age and risk tolerance. I'm more worried about outsmarting myself. I think there is too much risk in overthinking it."

"If rates go higher, the duration of my bond funds is low enough that the impact should be minor. And it's not rate rise #1 that I think about but when the one after that comes and how big that might be," said Peter5. "However, I still believe rates will stay lower and for longer than most talking heads claim."

NDinLA isn't making many changes either, aside from adding some leveraged closed-end municipal-bond funds that are selling at lower prices. "Maybe short-term rates might go up, but I don't see long-term rates going up."

"I pay less attention to what might happen," said FD1000, who is also standing pat. "Rising rates are supposed to rise for several years already. I also don't anticipate a quick and sharp rise anyway; actually, I think it will be slow and mild rise and most investors should do nothing special."

Ditto for Roberts: "I am maintaining same diversified bond investments, and continue holding the high-yield bonds and dividend growth stocks. Not too concerned about rising rates. If they rise slowly, the effect will be muted." 

I've Made Some Changes at the Margins
Other respondents, many of whom noted that they had been anticipating rate rises for many years, had made some moves within their portfolios. For most readers, this involved shifting from long-term bonds to shorter-term bonds, beefing up their cash position, or both.

"About four years ago I started preparing for rising interest rates by reducing my intermediate-term bond holdings and increasing my short-term bond holdings," said Chief K. "It turned out that being right, but being right several years too early, wasn't as much fun as I thought it would be."

Fastball agrees. "I have been preparing for rising rates for the past three to four years. I'm 85% in stocks, 10% in cash, and 5% in  Dodge & Cox Income (DODIX)."

Tomas47 adjusted bond fund holdings in 2013, but maintained the same overall allocation to fixed income. "I added a position in short-term investment-grade and converted my TIPS fund to the short-term TIPS fund, and did a quality upgrade from Dodge & Cox to  Vanguard Interm-Term Invmt-Grade (VFICX)." 

Aside from keeping three years' worth of living expenses in a credit union money market account to lower the risk of having to tap into bonds if rates suddenly go up, stagioneestate has been "increasing my allocation to short-term TIPS through  Vanguard Shrt-Term Infl-Prot Sec Idx Adm (VTAPX) by moving money out of  Vanguard Total Bond Market Index Adm (VBTLX). I would have done this anyway to bolster my retirement portfolio against unexpected inflation surges, but it does have the effect of slightly lowering the average duration of my bond holdings."

Darwinian, who said the "taper tantrum" of 2013 came as a bit of a surprise, adjusted bond holdings on the view that interest-rate risk is now more of a concern than credit risk. "I increased my short-term holdings (cash and short-term bonds) from two years of income to 3.5 years, to give my intermediate-term bonds more time to recover from rate shocks. Also, I migrated my investment-grade bonds to shorter durations and higher interest payouts, to obtain a smaller drop, and a more rapid recovery, from rate shocks."

I Made Some Larger Overall Shifts
Some respondents, meanwhile, revealed that they had decided to make some larger changes to their portfolios. In many cases, the moves were away from long-term bond funds and into shorter-duration holdings, but some readers had even made the decision to sell most or all of their bond holdings. 

Raymondl, for instance, sold 85% of bond fund holdings and more than 50% of balanced fund holdings. 

"[We] sold ALL our long-term bond funds," notes win1177, who reallocated much of that money into "short- to intermediate-bond funds--Vanguard muni funds in taxable accounts ( Vanguard Ltd-Term Tx-Ex Adm (VMLUX) and  Vanguard Interm-Term Tx-Ex Adm (VWIUX)) and Vanguard investment-grade bond funds in our retirement accounts ( Vanguard Interm-Term Investment-Grde Adm (VFIDX) and  Vanguard GNMA Adm (VFIJX))."

"I replaced bond funds and conservative allocation funds with moderate allocation funds," said OOPS101.

"Over the last few years, I've moved most of my fixed-income (bond) portfolio out of funds and into individual bonds. Bond values will take a hit from rising rates; however, if you hold individual bonds to maturity, you at least get their face value returned to you, which is more than you can say for bond funds," said Talent312.

"I moved about 40% of my 401(k), both stocks and intermediate bonds, into ultra-short bonds," said scotsailor.

"I have sold off my stock and bond fund portfolio and currently am 25% in laddered CDs and 75% in cash," said james57. "Just looking for opportunities to arise mainly in stock ETFs later in the year when the favorable seasonal starts up again. Staying out of all bonds for now."

I'm Focusing on Real Estate
Finally, a few readers noted that the current low-interest-rate environment had piqued their interest in real estate. 

"We bought a piece of real estate to take advantage of the current low interest rates.  Of course, we do feel that the property has the potential for a decent increase in future value," said seaside1.

"Instead of rebalancing the retirement portfolio, we paid off the mortgage, which makes us more risk-tolerant, notes bill heitbrink. "The retirement portfolio is 80% equities."

SeanDWB also isn't doing much in terms of portfolio reallocation, but notes that a real estate purchase may be in the offing. "I am looking to purchase property since rents where I live are high and monthly mortgage payments can be less than many rents. The one thing I am doing is trying to lock in a mortgage loan before the rates go up."

Karen Wallace does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.