Why Rising Rates Aren’t a Disaster for Bonds
Bond investors get anxious when rates rise suddenly, as Treasury yields have recently. But if your investment horizon is longer than a few months, rising rates are nothing to be afraid of.
Bonds are sensitive to interest-rate movements, and investors can initially suffer negative returns when yields rise. But if your investment horizon is longer than a few months, short-term losses probably don’t matter that much.
That’s because when it comes to your bond portfolio, time heals most wounds. As bonds mature, their prices drift back toward par. That means investors who sit tight will be able to reinvest the principal and coupon income that their portfolios pay in newer—and higher-yielding—bonds. This can offset short-term losses, and often increases total return.
Consider the recent spike in US Treasury yields. The 0.3% rise in January alone was abrupt and disorienting, even for many seasoned traders and professional money managers, and it will suppress near-term returns. But moves of that magnitude are rare—they’ve happened only 11% of the time since 1993. And history shows that when rates rise, the longer you hold your bonds, the better you do.
As Conditions Change, Flexibility Is Critical
Knowing which bonds to own—and how much—can be daunting. Today’s global bond market is complex, and not all bonds are alike. High-yielding, return-seeking assets such as high-yield corporate bonds are more closely correlated with global growth and equities than other risk-mitigating bonds like US Treasuries or German Bunds, which are more sensitive to interest-rate changes.
The good news, as we’ve seen, is that the power of time applies to all of them. Even so, investors should resist the urge to simply invest in everything and then put their fixed-income portfolios on autopilot. The multiyear run of rising asset prices and low interest rates may be winding down. Managing a portfolio today requires keeping track of changing conditions and valuations and recalibrating exposures as necessary.