- Even in a rising-rate environment, investment-grade bonds may provide positive performance when stocks struggle.
- While rising rates hurt bond prices in the short term, for long-term investors the higher interest payments can eventually benefit performance.
- Even when investment-grade bonds have experienced losses, the price drops have not been of the same magnitude as stocks have seen during bear markets.
- Despite rate risk, hiding in cash has historically often proven costly.
When interest rates rise and bond prices fall—as they have of late—it's natural for investors to be concerned. But short-term headwinds don't change the important role US investment-grade bonds can play in a portfolio. If you have a diversified portfolio that makes sense for your investment goals, time horizon, and financial circumstances, you can probably ignore the short-term concerns about a rate rise and stick with your plan.
Still worried? Here are 4 features of US investment-grade bonds that may help you maintain perspective.
1. Even in a rising-rate environment, bonds may still perform when you need them
Even in a period when bond returns may struggle in general, they can still play an important diversifying role in a portfolio, because they may rally at times when stocks fall—say, in the event of a crisis, economic slowdown, or other unforeseen market shock.
2. Over the long term, rising rates can help bond portfolio performance
In a portfolio of bonds, old bonds are maturing or being sold and new bonds are being added. When rates rise, it will generally cause the price of the bonds in the portfolio to fall, but the income from new bonds will be higher, and that added income has the potential to more than offset price losses over time—if you stay invested.
That's why the amount of time you plan to invest is important when it comes to bonds. Bonds and bond funds with shorter durations reach the point where additional income offsets price losses faster, so they may be more appropriate if you could need the money sooner. On the other hand, longer-duration investments may be more appropriate for diversification in a portfolio designed to meet long-term investment goals.
3. Even when bonds experience losses, the price swings aren't generally like stocks
Investment-grade bonds have historically tended to suffer smaller losses than stocks, and they very rarely post losses over longer time periods. Performance varies greatly for bonds of different credit qualities, but even during the worst bear market for bonds, the 40-year period of rising rates from 1941 to 1981, the worst 1-year loss for the Bloomberg Barclays US Aggregate Bond Index was just 5%. Over a 5-year period, the bond index never posted a loss. These performance numbers don't account for inflation—which can be an important consideration when evaluating investment performance, but they do illustrate the different magnitudes of price swings between stocks and bonds.
Of course, if you hold individual bonds to maturity, you may be able to ride out price fluctuations, knowing that as long as the bond issuer doesn't default, you will get your principal back at maturity and interest payments along the way.
4. Hiding can cost you
If you are worried about rising interest rates, you may be tempted to move out of bonds into cash. If so, you might avoid the risk that rising rates could hurt the value of your bonds, but what about inflation? Over time, a broadly diversified index of US investment-grade bonds has produced positive returns (after accounting for inflation) far more frequently than cash (see the chart below).
Moving money to the sidelines won't help manage the risk of declining purchasing power.
What you could do
You may have more bonds in your portfolio than you are comfortable with, or your particular bond holdings may leave you more exposed to interest-rate risk than you might like. But that's not true for everyone.
The bottom line
It has been a long time since investors faced a sustained period of rising rates, so it may come as a shock to be reminded that your bond funds can lose money. Still, investment-grade bonds rarely lose money over longer time periods, even when rates rise. It may make sense to review your strategy, but we think bonds play a role in most portfolios, regardless of the rate environment.
This information is intended to be educational and is not tailored to the investment needs of any specific investor.
In general, the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk, liquidity risk, call risk, and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so holding them until maturity to avoid losses caused by price volatility is not possible.
Bloomberg Barclays US Treasury Bond Index is a market value -weighted index of public obligations of the U.S. Treasury with maturities of one year or more. The Bloomberg Barclays US Corporate Bond Index measures the investment grade, fixed-rate, taxable corporate bond market. It includes USD-denominated securities publicly issued by US and non-US industrial, utility and financial issuers. The US Corporate Index is a component of the US Credit and US Aggregate Indexes.
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917