Municipal Bond Forum
Interest-rate sensitivity
Q
Our financial adviser says long-term municipal bonds “could have a lot of principal risk built into them because of their interest rate sensitivity. The solution is a combination of intermediate-term municipals and a portion of high-income munis to complement them and still maintain decent yields with much less interest rate risk.” We’re confused by the term “interest rate sensitivity.”
A
James A. Klotz responds:
“Interest rate sensitivity” is a phrase used to describe the inverse relationship between prevailing interest rates and bond prices. In other words, when interest rates fall, bond prices move higher and when interest rates rise, bond prices decline.
Selling bonds prior to their maturity date can result in a loss if long-term interest rates are higher at the time of sale than they were at the time of purchase.
Our experience as bond specialists has taught us that the additional, reinvestable tax-free income generated by long-term bonds, if held to maturity, more than makes up for any interest-rate risk. A decline in market value is not a loss unless bonds are sold.
Over the life of your long-term bonds, they will sometimes be worth more than you paid for them and sometimes less. Neither situation should trigger a sale as you bought the bonds for a steady stream of tax-free income.
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The responses provided in this forum are meant to address specific questions posed by investors about their municipal bonds and to provide market insight for our general audience. Please note, your investments, objectives, results and experience may differ significantly. Our answers and any potential strategies discussed should not be construed as a solicitation to buy nor sell any security or investment product. All investing entails risk.