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Why are Bonds Down So Much This Year?

    Posted by on November 23, 2022
    3 min read

It’s Saturday morning, you have a packed weekend coming up, and you want to quickly check your finances before you get on with your day. We’ve all been there, but you may have been greeted with an unpleasant surprise recently. Your bond investments in addition to your stocks were likely down double digits this year. It’s been a brutal year for the markets, but why haven’t bonds protected you from the storm?

Let’s start with how we got here. We’ve had stubbornly low inflation and a global pandemic that have forced the Federal Reserve to keep interest rates low to stimulate demand. Bonds have been an unattractive source of income with their paltry yields. But, with low rates and ample stimulus came the highest inflationary pressures in 40 years. The Fed has been hiking rates aggressively in 2022, aiming to make borrowing more expensive, slow down the economy, and ultimately cool inflation. How does this impact bond performance?

Bond prices are sensitive to interest rate movements, and they have an inverse relationship. As interest rates move up, bond prices go down. Why?

Let’s say I hold a bond that pays 2% interest every year.  As interest rates rise, new bonds become available paying 4% in interest. My bond loses value because it’s less attractive than new bonds available paying higher interest rates, and a reasonable investor would now pay less for it. Even though bond prices fluctuate in response to rates, the losses or gains you experience from the changes in the bond’s price alone are temporary, as the bond’s principal is returned if held to maturity (in the absence of a default). This happens whether you hold individual bonds or bond mutual funds.

The rapid rise in rates this year hurt bond prices, and the low starting yields didn’t help adequately cushion the blow. Although it’s been painful, the income generation potential from bonds is now at the highest levels in 15 years. You may be surprised to learn that higher rates help bonds over the long term because more income can be generated, reinvested, and compounded at higher rates. A bond’s total return is dominated by the income component, not the return from the price of the bond.

Looking forward, we encourage you to stay invested as current losses are likely to be offset by attractive levels of income generation. Please talk to your RegentAtlantic Wealth Advisor to learn how we’re making sure your portfolio is ready for the holidays!

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Please remember that different types of investments involve varying degrees of risk, including the loss of money invested. Past performance may not be indicative of future results. Therefore, it should not be assumed that future performance of any specific investment or investment strategy, including the investments or investment strategies recommended or undertaken by RegentAtlantic Capital, LLC (“RegentAtlantic”) will be profitable.

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