Bond prices fall as interest rates rise

November 28, 1993|By Knight-Ridder News Service

Investors chasing higher interest rates have switched billions of dollars out of low-yielding money-market funds and bank accounts into mutual funds that invest in bonds.

Some of those investors have received a lesson in the past few weeks: The higher yields paid by bonds and bond funds carry with them the risk that the value of principal can fall.

Bond prices move in the opposite direction from interest rates. Interest rates on long-term bonds have moved up more than one-half of a percentage point since mid-October. The yield on the 30-year Treasury bond that matures in August 2023, for example, rose from 5.79 percent on Oct. 15 to 6.38 percent Monday. The market value of that bond fell 7.65 percent, from $1,065.94 per $1,000 face value to $984.38.

Prices have also fallen for mutual funds that invest in long-term bonds. The Vanguard Long-Term Corporate Bond fund is down 3.45 percent since mid-October, even after accounting for a dividend paid on Nov. 1. The T. Rowe Price U.S. Treasury Long-Term Bond fund isdown 3.7 percent since mid-October, after including the dividend it paid on Oct. 29.

So far, most investors have taken in stride the fall in bond prices.

"There's been no movement out of bond funds, nor have we seen a large number of calls from shareholders who are concerned about the rates moving up," said Neal Litvack, marketing chief at Fidelity Investments, the biggest fund group.

But, he said, investors who have sent in money over the past few weeks have favored money-market funds over bond funds. "That's a very different picture from six months ago," he said.

At T. Rowe Price, the Baltimore fund group, "there has been some reaction to the concern about higher rates," said spokesman Steve Norwitz. "People do seem to be shifting some money out of the longer-term bond funds into money-market funds. It's not a big turnaround, but it is a change in the pattern we had before, when we saw steadily positive inflows over most of the year."

Some shareholders at the Vanguard Group of funds in Valley Forge, Pa., moved money out of long-term bond funds and into short-term bond funds or money funds earlier in November, said spokesman Brian Mattes. But the shift amounted to far less than 1 percent of the assets in Vanguard bond funds.

*

A recent U.S. Tax Court ruling highlights the importance of estate planning.

An elderly man wrote instructions to his brokerage firm to liquidate securities in order to send $10,000 to each of 20 nieces and nephews, says a report on the case in Tax Notes, the weekly bible on tax matters. But the man died the same day his letter was delivered, before the brokerage firm could carry out his instructions.

The firm carried out the instruction two days later, and the $200,000 later was excluded from the dead man's estate. The IRS contended that the $200,000 should have been in the estate and subject to tax.

The Tax Court ruled that the IRS was right because the gifts were not completed before the man died. The man's letter to his brokerage firm did not constitute a trust for the nieces and nephews, the court said, because it made no mention of a trust.

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