Making Sense of Bond Prices

First a Quick Refresher 

When interest rates go up, bonds lose value.  How much the bond’s value declines depends almost entirely on the bond’s maturity date.  For example, if you buy a Treasury bond that pays $40 / year and the next day the government starts issuing new bonds that pay $50 / year, your bond is no longer worth what you paid for it.  If your bond matures in one year, someone may offer you $10 less than you paid.  If your bond matures in 10 years, someone may offer you $100 less than you paid.  The longer the bond, the more the price declines when interest rates go up. 

But you get all your money back at maturity! 

Yes. If you own a bond and it doesn’t default, you will get your money back.  But that doesn’t change the fact that your statement may look very ugly in the interim.   

What is Happening Now?

Yields on 30-year Treasuries have gone from a low of around 1% in March 2020 to nearly 5% a little more than three years later.  If you bought a 30-year bond in 2020, you have seen price declines comparable to those experienced by stock investors during the dot-com crash of 2000 and the Great Financial Crisis of 2007. 

Source: Ben Carlson via Datatrek

Shorter bonds have experienced smaller, but still historic, declines as well.   

Has This Ever Happened Before?

At the start of 1950 long-term U.S. government bonds yielded just over 2%. By 1959 that rate would hit 4.5%, by 1969 it was up to 6.9% and by 1979 it was 10.1%.  By 1981 rates climbed all the way to 15%.

In a little over 30 years, long-term bond yields went from 2% to 15% but there was never a crash in values like we have seen today.  Instead, it was death by a thousand cuts. For that 30-year period, annual nominal returns were a little more than 2% per year but in real terms (accounting for inflation), Treasuries lost almost 60% of their value. 

I Thought Bonds Were Safe?
 
How much risk you are taking is entirely dependent on how you define risk.  If your idea of minimizing risk is to invest in something that promises to give your nominal dollars back at some point down the road, Treasuries and Treasury ETFs have very little risk.  If you define risk as something that minimizes price fluctuations from one day to the next, cash and money markets have very little risk.  If you define risk by looking at the percentage of positive, inflation-adjusted, rolling 30-year periods for an investment, the stock market has very little risk. 

Since we generally define risk for our clients in terms of “the risk of running out of money during a long retirement,” our typical recommendation is for investors to be more heavily weighted to stocks with allocations to bonds and cash as needed to accommodate the client’s specific situation and preferences. 

While today’s higher interest rates make bonds more attractive than they have been in years - and notably increased our forward income projections - our long-term strategies have not fundamentally changed. 

If interest rates drop from here, investors that are loaded up on cash will be forced to reinvest at lower rates.  If interest rates rise, investors that locked in rates with longer bonds will see their prices decline.  If the stock market drops, investors will need a more stable source of cash as they wait for things to rebound.  These things have been true and will continue to be true.   

Investing in retirement is all about balancing these tradeoffs and making small adjustments along the way. So, while bonds are certainly more attractive than they have been, and we don’t see interest rates going up too much farther from here, we don’t recommend loading the boat.  Markets can do things we weren’t expecting, and history tells us that seemingly low-risk strategies can turn into painful trades very quickly.