By Ryan Yuhnke
There’s nothing worse than investing your hard-earned money in an asset you think is safe only to see it losing value day after day. This is what bond investors throughout the country are experiencing as nearly $87 billion was pulled from the bond market in the first quarter of 2022. (1) So, why are bonds losing money? Here are 3 things to know about the bond market as you make decisions about your portfolio and why chasing past performance from the last 40 years might no longer be as successful as it has been in the past.
Bond Prices and Interest Rates Are Inversely Related
There is an inverse relationship between bond prices and interest rates, meaning as interest rates rise, bond prices fall. This is because newly issued bonds have higher rates of return than older bonds, reducing the demand for older bonds and generally resulting in a loss if you were to sell.
The Federal Reserve raised interest rates in March and May and plan to continue raising rates throughout 2022 as a way to combat inflation. (2) These ongoing rate increases indicate that existing bond prices will continue to fall, at least for the short term.
Interest Rates and Bond Yields Are Directly Related
While bond prices and interest rates move in opposite directions, bond yields and interest rates move together. That means that both existing bonds and newly issued bonds will provide a greater return as interest rates go up. But this only helps if your bond is newly acquired, either buying an existing bond at a discounted price or buying a newly issued bond with a higher coupon rate. Since most investors already have a portfolio of bonds bought at a higher price and a lower coupon rate, they are losing money in the current rising rate environment.
As shown in the graph below, bond yields have steadily declined because interest rates have dropped over the last 40 years. You can see a dramatic decline in 2020, which is when the interest rates hit near-zero during the pandemic. When interest rates were near zero as shown in the highlighted areas, you should have sold your bonds because the only other way they could have appreciated in value was if interest rates went negative. Having a sell strategy (most investors don’t) would have allowed you to sit in cash or very very short-term U.S. T-bills and wait for rates to rise as they have recently, and avoid the steep losses that have taken place in early 2022.
Now that interest rates are on the rise, bond yields are going up too. (3) This is especially true for longer-term bonds, which are more affected by changes in interest rates than their short-term counterparts.
Not All Bonds React the Same
Not all bonds are the same, so they act differently in a rising rate environment:
- Long-term bonds: These bonds typically take 12-30 years to mature and they are most affected by rising interest rates. As rates go up, demand for long-term bonds drops quickly.
- Short-term bonds: These bonds take 1-5 years to mature. They aren’t nearly as sensitive to rising interest rates because they mature so quickly. In fact, sometimes rising rates create an increased demand for short-term bonds as investors shy away from long-term ones, waiting for rates to rise.
- Intermediate-term bonds: These fall between 5-12 years to maturity. As could be expected, they are not quite as stable as short-term bonds but much less volatile than long-term bonds.
Therefore, it makes sense to be confident in the direction of interest rates especially if you are taking the risk with intermediate and longer maturities. Because longer-term bonds are more affected by changes in interest rates, it may make sense to offload these before interest rates rise even more. Understanding the relationships between bond prices, bond yields, and interest rates is one of the best things you can do to ensure you are investing wisely in a volatile bond market.
The Good News About Bonds
The good news about bonds is that just because they are declining in price doesn’t mean they have to wreak havoc on your overall portfolio. At Court Investment Services, we can help you manage your clients’ probate and trust assets and make the appropriate changes so that rising interest rates can actually work in your favor. To learn more about our wealth management process, schedule an appointment by contacting us at (800) 880-2760 or Contact@CourtInvestmentServices.com.
About Ryan
Ryan Yuhnke is founder and Principal at Court Investment Services, an independent, fee-based investment firm that serves attorneys and fiduciaries as they manage estate-held assets. With two decades of experience, Ryan’s proactive, relationship-based process saves his clients time and money while putting them first in everything. He provides services and support to help attorneys and professional partners oversee and manage special-needs trusts, estates, conservatorships, guardianships, and other court accounts, including IRAs, 401(k)s, and all manner of retirement accounts that also fall under his clients’ management. Ryan is known for his commitment to excellence and transparency and his deep knowledge of probate laws, court compliance, and strategies to keep assets safe while abiding by all court and probate code directives. Ryan’s goal is to make his clients’ lives easier, providing investment support and education along the way.
Ryan has a bachelor’s degree in economics from the University of California, Irvine, and built his career working in banks, national investment firms, and registered investment advisory firms (RIAs.) Prior to starting CIS, he earned the title of First Vice President, and Portfolio Management Director while employed at Morgan Stanley in Newport Beach, CA. When he’s not working, Ryan can be found traveling and enjoying time with family and friends. This might include golf in the warmer months and snowboarding in the cooler months. To learn more about Ryan, connect with him on LinkedIn.
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(1) https://www.barrons.com/articles/bond-funds-worst-quarter-51649428107
