Common Sense: Interest-Rate Shift to Affect Your Fixed-Income Investments
SmartMoney</br></br>LAST WEEK'S gentle summer rally was helped along by a cease-fire in Lebanon, a modest drop in oil prices, and especially a growing consensus that the Federal Reserve may have indeed stopped raising interest rates, as opposed to "pausing" in its pursuit of higher rates.</br></br>Still, this is no time for complacency. Interest-rate cycles usually last years, and don't change overnight. Even so, it's becoming apparent that we're in the midst of a historic shift from a long period of rising short-term interest rates to one of flat to declining rates, which will likely have an impact on the fixed-income portion of your portfolio.</br></br>Lately, it's been pretty easy to be a fixed-income investor. All you had to do was put cash in a money-market fund and collect ever-rising yields, while putting your bond allocation into one- to three-year certificates of deposit. With the yield curve nearly flat, and even inverted at times, you could capture maximum returns of close to 5% with minimal risk. True, this approach wasn't earning double-digit returns, but you sure didn't lose any sleep.</br></br>It also turns out this was a good strategy this year, one of those relatively rare periods when cash outperformed longer-term bonds. So far in 2006, cash equivalents earned 2.9%, while 10-year Treasurys lost 1%.