Evaluate fixed-income investments when rates fall

If you own a business and need to take out loans, you've probably been happy to see interest rates fall, as they've done for the past couple of years. And the same is true if you've applied for a mortgage or refinanced your home. But if you're an in-vestor, the story is a bit more complex.

If you bought a bond a few years ago, then you shouldn't be sorry that rates have fallen. That's because, all things being equal, the value of your bond has risen; it's worth more to investors be-cause it offers a higher interest rate than what's currently available on the market. So, if you were to sell your bond on the secondary market you would typically be able to receive a price that's higher than the face value.

Mortgage-based securities

On the other hand, if you happen to invest in mortgage-based securities such as those issued by Ginnie Mae (the Government National Mortgage Asso-ciation) or Fannie Mae (the Federal Na-tional Mortgage Association) - you may be looking at a slightly different picture. When interest rates drop and many people refinance their mortgages, investments based on those mortgages will re-flect the rates at which new loans are made.

Therefore, you are more likely to re-ceive some of your principal back sooner than expected, which may improve your return but reduces the potential for price appreciation. Of course, this is a major reason why these types of securities generally pay higher interest rates than Treasury bonds.

Looking to buy

Thus far, we've looked at fixed-income investments that you may already own. But what about if you want to buy one now? If you'd like to supplement your current income with interest payments from a bond, lower rates are not particularly welcome news.

However, bonds still provide good in-come in the form of regular interest payments, and you can expect high-quality bonds to repay their principal at maturity. In addition, bonds can help you diversify your portfolio and diversification is always a key to long-term investment success.

Still, there are steps you can take to help control your income, even in a low-rate environment.

For example, when purchasing a bond, you may want to get one with a longer maturity (more than 10 years). Usually, but not always, longer-term bonds pay higher rates than shorter-term ones. However, you'll have to keep in mind that longer-term bonds carry a greater interest-rate risk the possibility that rising rates will reduce the value of your bond.

Ultimately, you'll want to look at your entire fixed-income portfolio from time to time to see if it still meets your long-term objectives. You may want to make some adjustments, depending on your need for income and your overall portfolio diversification. Before you make any drastic changes, though, remember that you're investing for the long term - and you should not make wholesale changes based on short-term interest rate predictions or market movements.

(Betty J. Neal, certified financial planner, is an investment representative with Edward Jones Investments.)