The Fed is tightening monetary policy, the yield curve is flattening, and credit spreads are near historically tight levels. What does that mean for people saving and investing for retirement -- and for people already retired? What changes should investors consider for the fixed-income portion of their portfolio?

First, it's worth noting that investing in bonds is usually part of the portfolio picture for those near or in retirement, said Judith Ward, a senior financial planner at T. Rowe Price.

"Bonds help to dampen the overall volatility of a stock portfolio," said Ward. "Bonds also provide regular interest payments that may enhance an income stream in retirement. However, when rates are on the rise, it may negatively impact the price component of bonds. Bond and bond funds with longer durations may be impacted the most."

Rising Rates Are Good for Investors Over the Long Term

The good news, she said, is that rising rates are beneficial for investors over the long-term. "This increases the coupon component of overall return," Ward said. "Over the short-term there may be price declines, but they tend to be very short-lived and offset to a degree by this coupon component."

According to Ward, since 1993 (the year prior to Fed's tightening period) there has only been three years where the Bloomberg Barclays U.S. Aggregate Bond Index has had slightly negative returns. Read "Monetary Policy Tightening and Long-Term Interest Rates" from the Red Reserve Bank of Cleveland.

"Investors can hold their bond fund positions, with a little patience, and reap the reward of higher coupon payments," said Ward.

Of course, reaping those rewards will require a bit of diversification.

"Just like investors diversify their stock holdings, investors should diversify their bond holdings," said Ward. "A mix of U.S., international, credit quality and durations hedge against these kinds of cycles."

Outside the U.S., for example, Ward noted that countries are on very different economic cycles. Additionally, she said high-yield bonds are not impacted as much from interest rate changes, but by the economy and company fundamentals.

Ward also noted it's important for investors to have a balanced approach near and in retirement which includes an allocation to stocks. "The growth potential of stocks helps bolster returns over a long retirement horizon, while bonds help to cushion the short-term volatility," she said.

What's Your Time Horizon?

Colleen Jaconetti, senior retirement strategist in Vanguard Investment Strategy Group, offered another way to think about your fixed-income investments in a rising-interest-rate environment.

A bond portfolio that constantly buys new issues and experiences the maturation of older issues confronts two contrasting forces in a rising-interest-rate environment. On the one hand, the prices of existing bonds in the portfolio fall. On the other hand, the bond portfolio buys newer issues with higher yields.

"On a net basis, our findings suggest that an investor with a time horizon longer than the portfolio's duration may actually benefit from a rising-interest-rate environment," said Jaconetti "This is because an increase in interest rates benefits the long-term investor by providing an opportunity to incorporate bonds with higher interest rates over time."

This effect, she noted, overwhelms the short-term decrease in portfolio value caused by a rising-rate environment."

Of course, timing matters, and not all investors can wait for the long term.

What's more, Jaconetti said, many variables -- including spending from the portfolio and movements of interest rates -- can affect the success of a retirement portfolio.

Match Asset to Liabilities

According to Jaconetti, there's a simple -- though imperfect -- rule of thumb that helps make this point clear. "If the time frame of your investing goal exceeds the time frame of your bond portfolio (a medium-term goal matched with short-term bonds, or a long-term goal paired with bonds not quite as long term) rising rates will work out in your favor, maybe decidedly so," she said.

Jaconetti gave this example: If you have a big cash need in the near future -- say, a tuition bill coming due in a few years -- and you own bonds that are long-term in nature, this time frame mismatch could spell trouble if rates rise sharply; you'd be selling bonds that would be worth less. But if you're saving to retire 10 or 15 years down the road and rates are steadily rising, over time you'll be earning higher and higher yields.

Jaconetti noted that Josh Barrickman, head of fixed income indexing for the Americas at Vanguard, calls it "'the virtuous cycle of compounding interest at a higher rate.'"

"The bottom line is, you can end up better off than if rates hadn't risen because you're earning more income, which over time more than washes away any price hit," she said. Read Rates Change, But the Role of Bonds Doesn't.

Risk in Stocks Greater Than Risk in Bonds

When evaluating the potential risks in the bond market, Jaconetti said, it's critical to remember exactly why bonds are an integral part of a well-thought-out asset allocation plan -- to diversify the risk inherent in the equity markets.

"Simply put, while the fears of rising interest rates may be legitimate, a potential bear market in bonds is dramatically different from a bear market in stocks, or other risky assets," she said. "While rising interest rates can create negative returns in bonds, particularly for longer-duration bonds, the magnitude of potential losses is unlikely to be anything close to a bear market in equities."

Historically, Jaconetti noted, stocks have had far more downside risk than bonds, with negative returns in more than 25% of the 12-month return observations. "In 6% of observations, they experienced a bear market, which is defined as a loss greater than 20%," she said. "Bonds, on the other hand, have realized negative returns in a little more than 15% of observations and have never experienced a bear market of that magnitude in the U.S. In fact, a loss of greater than 10% is an event so rare, it's only happened in two of the almost 1,100 12-month return observations that we examined. Compare this with stocks, where a more-than-10% loss has happened more than 13% of the time. Big difference."

Don't Try to Time the Market

Jaconetti also noted that trying to time the markets is extremely difficult. "Not only do you have to be correct on timing on two fronts (out of and back into the market), but you also need to know that you are 'parking' the proceeds in an asset class that will outperform," she said.

To be sure, it's easy to understand that bond investors, facing the prospect of rising rates, are naturally inclined to either shorten duration or move into cash.

However, "investors who shift from bonds to cash will realize an opportunity cost in the form of lower yield while they wait for the anticipated rise in rates," Jaconetti said. "The longer the wait, the greater the yield give-up."

Take Less Risk for Income

Brian Rehling, co-head of global fixed income strategy for the Wells Fargo Investment Institute said a recent report about how rising interest rates can affect investors, "First, there could be a boost in returns. After years of earning next-to-nothing on savings accounts, a rate increase could finally help your money work better for you."

Second, Rehling said investors should be able to take less risk for income. "If you're retired or about to retire, you've been concerned with generating income," he said. "And throughout the recent low-interest rate environment, yield has been hard to come by. With a rate increase, many traditional lower risk income-generating investments like CDs, may begin to earn higher returns again."

Third, Rehling urged investors to use caution when investing in long-term securities. "When rates climb, bond investors should be careful not to have too much locked in long-term low yielding products," he said.

Next, Rehling recommends looking for equity opportunities. "Just because interest rates go up doesn't mean the equity bull market is over," he said. "In fact, we expect some sectors like consumer discretionary, information technology and industrials to continue to grow."

Got questions about the new tax law, Social Security, retirement and/or investments? Email Robert.Powell@TheStreet.com.

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