What strategies can investors use to manage interest rate risk?

Investors manage interest rate risk, which is the risk that changes in interest rates will negatively affect the value of their bond investments, through a combination of strategies that enhance flexibility and limit exposure. One effective method is diversifying bond maturities, often referred to as a "barbell" or "ladder" approach. By holding bonds with different maturities, investors can mitigate the impact of rising interest rates on their overall portfolio. This diversification allows some bonds to mature and be reinvested at potentially higher interest rates while still benefiting from the yields of longer-term bonds.

Additionally, using floating-rate bonds, which have interest payments that adjust with market rates, is another strategy to combat interest rate risk. These bonds typically pay a lower fixed rate initially, but as interest rates rise, the coupon payments can also increase, providing more income and protecting the investor’s capital from declines in bond prices. This combination helps balance potential rewards while minimizing risks associated with fluctuating rates.

In contrast, strategies such as investing exclusively in long-term bonds or holding bonds to maturity may not effectively address interest rate risk. Long-term bonds typically have greater price sensitivity to interest rate changes, leading to potential losses if rates rise. Holding bonds to maturity can protect investors from market volatility,