Why are bonds performing so poorly?
Interest rate changes are the primary culprit when bond exchange-traded funds (ETFs) lose value. As interest rates rise, the prices of existing bonds fall, which impacts the value of the ETFs holding these assets.
What causes bond prices to fall? Bond prices move in inverse fashion to interest rates, reflecting an important bond investing consideration known as interest rate risk. If bond yields decline, the value of bonds already on the market move higher. If bond yields rise, existing bonds lose value.
As for fixed income, we expect a strong bounce-back year to play out over the course of 2024. When bond yields are high, the income earned is often enough to offset most price fluctuations. In fact, for the 10-year Treasury to deliver a negative return in 2024, the yield would have to rise to 5.3 percent.
Bond prices decline when interest rates rise, when the issuer experiences a negative credit event, or as market liquidity dries up. Inflation can also erode the returns on bonds, as well as taxes or regulatory changes.
If prevailing interest rates increase above the bond's coupon rate, the bond becomes less attractive. In this situation, the bond price drops to compensate for the less attractive yield.
The table on the right shows that bond prices often recover within 8 to 12 months. Unnerved investors that are selling their bond funds risk missing out when bond returns recover. It is important to acknowledge that some of those strong recoveries were helped by bond yields that were higher than they are today.
As inflation finally seems to be coming under control, and growth is slowing as the global economy feels the full impact of higher interest rates, 2024 could be a compelling year for bonds.
Unless you are set on holding your bonds until maturity despite the upcoming availability of more lucrative options, a looming interest rate hike should be a clear sell signal.
Waiting for the Fed to cut rates before considering longer term bonds isn't our preferred approach. The bond market is forward-looking and long-term Treasury yields typically decline once investors believe that rate cuts are coming.
Rising yields can create capital losses in the short term, but can set the stage for higher future returns. When interest rates are rising, you can purchase new bonds at higher yields. Over time the portfolio earns more income than it would have if interest rates had remained lower.
Should I pull money out of bonds?
Because your rate changes every six months, it's smart to withdraw when your penalty will be based on a lower rate—and avoid cashing out when you'd be forfeiting a high rate. The issue date of your I bond can tell you the optimal time to withdraw—even down to the best day of the month to cash out.
Face Value | Purchase Amount | 30-Year Value (Purchased May 1990) |
---|---|---|
$50 Bond | $100 | $207.36 |
$100 Bond | $200 | $414.72 |
$500 Bond | $400 | $1,036.80 |
$1,000 Bond | $800 | $2,073.60 |
Default risk is the possibility that a bond's issuer will go bankrupt and will be unable to pay its obligations in a timely manner if at all. If the bond issuer defaults, the investor can lose part or all of the original investment and any interest that was owed.
When interest rates rise or fall, investors in mutual funds and ETFs may be more likely to experience volatility in the performance of their investment, while investors in individual bonds who hold their bonds to maturity may not realize any impact.
Bond prices have an inverse relationship with interest rates. This means that when interest rates go up, bond prices go down and when interest rates go down, bond prices go up.
As the price of a bond increases or decreases, the true yield will change—straying from the coupon rate to make the investment more or less enticing to investors. All else equal, when a bond's price falls, its yield increases. When a bond's price increases, its yield decreases.
Yields to Trend Lower
Key central bank rates and bond yields remain high globally and are likely to remain elevated well into 2024 before retreating. Further, the chance of higher policy rates from here is slim; the potential for rates to decline is much higher.
Government debt and the 10-year Treasury note, in particular, are considered among the safest investments. Its price often (but not always) moves inversely to the trend of the major stock market indexes. Central banks tend to lower interest rates in a recession, which reduces the coupon rate on new Treasurys.
Traditionally, the answer has been that bonds provide diversification and income. They zig when stocks zag, providing income for spending needs. In finance terms, bonds have “low correlation” levels to stocks, and adding them to a portfolio would help to reduce the overall portfolio risk.
CDs are an excellent place to park your cash and earn interest on your balance. Although there's a risk of inflation outpacing CD interest rates, they are virtually guaranteed earnings. Bonds, on the other hand, may deliver higher returns and regular income via interest payments.
What is the best government bond to buy?
- iShares Core U.S. Aggregate Bond ETF (AGG)
- Vanguard Total World Bond ETF (BNDW)
- Vanguard Core-Plus Bond ETF (VPLS)
- DoubleLine Commercial Real Estate ETF (DCRE)
- Global X 1-3 Month T-Bill ETF (CLIP)
- SPDR Portfolio Corporate Bond ETF (SPBO)
- JPMorgan Ultra-Short Income ETF (JPST)
- iShares 7-10 Year Treasury Bond ETF (IEF)
With more than a decade or two of working years left until retirement, it's important to maintain the growth potential of your portfolio through an appropriate allocation to stocks. In your 50s, you may want to consider adding a meaningful allocation to bonds.
Inflation is a bond's worst enemy. Inflation erodes the purchasing power of a bond's future cash flows. Typically, bonds are fixed-rate investments. If inflation is increasing (or rising prices), the return on a bond is reduced in real terms, meaning adjusted for inflation.
But investors who sell a bond before it matures may get a far different amount. For example, if interest rates have risen since the bond was purchased, the bondholder may have to sell at a discount—below par. But if interest rates have fallen, the bondholder may be able to sell at a premium above par.
You can make money on a bond from interest payments and by selling it for more than you paid. You can lose money on a bond if you sell it for less than you paid or the issuer defaults on their payments. When you buy or sell a bond, the commission is built into its price.
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