If you have tuned into financial media over the past few weeks, you have heard plenty of talk about the uncertainty surrounding Fed policy—with many investors wondering how fast and high the Fed will raise rates.
While the prospect of a Fed policy change is significant, it doesn’t mean rates overall will rise dramatically, and it doesn’t change the important role bonds can play in a portfolio. If you have a diversified portfolio that makes sense for your investment goals, time horizon, and financial circumstance, you can probably ignore the short-term concerns about a rate change.
Here are four features of bonds that may help you maintain your perspective.
|1.||Even in a rising rate environment, bonds may still perform when you need them.|
If rates rise, it could cause the value of your bonds and bond funds to fall, and that kind of loss can cause anxiety and concern. But it makes sense to remember why you invested in the first place. Even in a period when bond returns may struggle, they can still play a role in a portfolio, because they may rally at times that stocks fall—say in the event of a crisis, economic slowdown, or other unforeseen event.
|2.||For long-term investors, rising rates can help bond fund performance.|
If rates go up, the prices of bonds should drop. But that’s not where the story ends. In a portfolio of bonds, the income from new bonds will be higher after rates rise, providing 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 funds with shorter durations reach this breakeven point faster, so they may be more appropriate if you may 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, they aren’t like stocks.|
Investment-grade bonds have historically tended to suffer smaller losses than stocks, and they very rarely post losses over longer time periods. While performance varies greatly for bonds of different credit qualities, even during the worst bear market for bonds, the 40-year period of rising rates from 1941 to 1981, the worst one-year loss for the Barclays U.S. Aggregate Bond Index—a broad index meant to track investment-grade bonds—was just 5%, and over a five-year period, bonds never posted a loss.
Of course, if you hold individual bonds to maturity, you may be able to ride out price fluctuations, knowing that so 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 move out of bonds into cash, 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 U.S. investment-grade bonds— the Barclays U.S. Aggregate Bond Index— 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 invest 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. Start by comparing your current portfolio with your investment strategy using our Planning & Guidance Center (login required). Try our fixed income analysis tool (login required). to see what rate changes could mean for you.
The bottom line
It has been a long time since investors faced a 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. So it may make sense to review your strategy, but we think bonds play a role in most portfolios, regardless of the rate environment.
- Read our latest Viewpoints on the rate outlook.
- Try Fidelity’s fixed-income analysis tool.
- Get a holistic view of your retirement plan with our Planning & Guidance Center, and explore changes that may help you become better prepared.
- Use our research centers to find bond funds, individual bonds, and ETFs
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917