Retired Money: How Bond ETF investors can minimize risk of rising rates

My latest MoneySense Retired Money column has just been published: click on the highlighted text to retrieve the full column: Should investors even bother with Bonds any more?

In a nutshell, once again pundits are fretting that interest rates have been so low for so long, that they inevitably must soon begin to rise. And if and when they do, because of the inverse relationship between bond prices and interest rates, any rise in rates may result in  capital losses in the value of the underlying bonds.

In practice, this means choosing (or switching) to bond ETFs with shorter maturities: the risk rises with funds with a lot of bonds maturing five years or more into the future, although of course as long as rates stay as they are or fall, that can be a good thing.

As the column shows, typical aggregate bond ETFs (like ETF All-Star VAB) and equivalents from iShares have suffered losses in the first quarter of 2021. Shorter-term bond ETFs that hold mostly bonds maturing in under five years have been hit less hard. This is one reason why in the US Vanguard Group just unveiled a new Ultra Short Bond ETF that focuses on bonds maturing mostly in two years or less.

The short-term actively managed bond ETF is called the Vanguard Ultra Short Bond ETF. It sports the ticker symbol VUSB, and invests primarily in bonds maturing in zero to two years. It’s considered low-risk, with an MER of 0.10%.

Of course, if you do that (and bear the currency risk involved, at least until Vanguard Canada unveils a C$ version), you may find it less stressful to keep your short-term cash reserves in actual cash, or daily interest savings account, or 1-year or 2-year GICs. None of these pay much but at least they don’t generate red ink, at least in nominal terms.

As the article notes, investors will find the so-called “high interest savings accounts” offered by the big banks pay a pittance; you can much better by parking money ($100,000 at a time to have the added protection of CDIC) in virtual banks like EQ Bank or Canadian Tire Bank.

Who wants volatility in the low-volatility portion of your portfolio?

One of the sources consulted in the MoneySense article is Financial consultant Aaron Hector, vice president with Calgary-based Doherty & Bryant Financial Strategists. He thinks the main concern right now is “the potential for volatility in what have long been the less volatile portion of your portfolio.” Since the longer the bond, the more an interest rate rise will impact them, short-term bonds will help mitigate the volatility, Hector says. That said, even short-term bonds will not react positively to rises in interest rates. If you’re saving for short-term cash requirements, he suggests using high-interest savings accounts rather than short-term bonds. He prefers high-interest savings accounts to GICs currently because the former are more flexible but the rate differential is minimal.



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