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How to Stress-Test a Portfolio's Interest-Rate Sensitivity

May 06, 2011 8:46 PM ET
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May 07, 2011 - How to Stress-Test a Portfolio's Interest-Rate Sensitivity - by Morningstar Investment Research

For example: As a 68-year-old new retiree, you have about half of your portfolio in bond funds. But frankly, I'm questioning the wisdom of such a large fixed-income position given the prospect of higher interest rates. How can you tell how interest-rate-sensitive my portfolio really is?

Morningstar director of personal finance Christine Benz commented on the timeliness of this question. She said investors, especially those in or nearing retirement, are rightly concerned about how the so-called safe portions of their portfolios are likely to behave in a sustained period of rising interest rates. It's definitely smart to think about what risks might lurk in your portfolio, particularly in segments that you expect to be drawing upon for living expenses within the next several years. And it's also true that after a few decades' worth of declining interest rates, rates have much more room to go up than they do to go down further. That could spell trouble for bond prices if rates head up and continue to spike. Click here to read more.

How Much Should You Rely on Beta?

After the bear market, I've become a lot more attuned to how risky my investments are. Not being a finance person, I'm not sure how to use statistics like beta when selecting and monitoring my investments. Any pointers?

Morningstar assistant site editor Esther Pak noted that individual mutual fund Analyst Reports on Morningstar.com feature a Ratings & Risk tab, which lists a number of quantitative risk/return measures. These measures include Morningstar's risk-adjusted ratings, several measures of volatility, such as standard deviation, and various modern portfolio theory statistics, such as beta, for the three-, five-, 10-, and 15-year periods. Each of these measures provides a different look at a fund's risk, volatility, return, or a combination of those factors. MPT is rooted in the assertion that there's no free lunch--you'll only obtain higher returns if you're willing to take on more risk. At the same time, MPT holds that diversifying a portfolio across multiple assets can help decrease its risk level. In Part 1 of a series on modern portfolio theory, Pak discussed using beta as a tool to determine the level of a fund's index-related risk.

Among the other topics we addressed this week:

* Fidelity's Experience Proves Bigger Doesn't Mean Better It's not for lack of effort that the Boston behemoth's culture is just average.

* Is the Recovery Leaving Some Workers Behind? As the job market continues to improve, lower-skilled workers and the long-term unemployed are still struggling.

* Inside the Vanguard Science Project Vanguard's more-patient shareholders outperformed the rest.

* How to Stress-Test a Portfolio's Interest-Rate Sensitivity Following this rule of thumb might serve you well in case interest rates go up.

* For These Funds, Seniority Hasn't Equaled Success Despite having long-tenured managers, these funds haven't distinguished themselves.

* How Apple Will Continue Its Growth Despite having investment limitations related to an Islamic mandate, Amana's Nicholas Kaiser is finding value in the tech sector, particularly with Apple's innovative progress.

* HOLDRS ETFs With Low Fees and Low Valuations An inexpensive way for ETF investors to access some undervalued sectors.

* Beware the Emerging-Markets Bandwagon Most of the new emerging-markets funds can safely be ignored.

* The Error-Proof Portfolio: Are Bonds Adding to Your Equity Exposure? Check correlations before adding credit-sensitive fixed-income assets to your portfolio.

* Expense Ratios Are Falling Overall, fund investors are paying less for fund management.

* What We Learned at the Berkshire Meeting Morningstar's Drew Woodbury and Gregg Warren highlight the key themes and takeaways from the 2011 Berkshire Hathaway Meeting.

* Question Marks Still Hang After Berkshire Meeting Shareholders' concerns about who will replace Buffett grow larger and larger with each year that passes.

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