First, it should be noted that we already recently released a blog/vlog focusing on the stock market. This blog/vlog will focus on bonds.
Historically, bonds have long been considered a more “safe” asset class relative to stocks, because historically, although their long-term returns are lower than stocks, they are also usually less volatile. So for more conservative investors, bonds can be an attractive investment to those that can’t stomach the ups and downs of stocks. Even moderate or moderately aggressive investors typically have a portion of their portfolio in bonds for diversification. Some might wonder then, why are bonds dropping so much in value this year?
As of May 6th, 2022, the Bloomberg U.S. Aggregate bond index was down -10.51% and the US Corporate bonds as represented by Bloomburg Investment Grade Credit index was down -13.89%. This is actually pretty close to stock market returns so far this year. The S&P 500 Index was down -13.07% during the same period.
Remember that bonds are actually a loan to a company or a government, in exchange for interest payments and a guarantee to pay back the loan after a certain amount of time. If you keep the bond until its maturity date, you would get back the amount you paid for the bond (based on the ability of the company or government to pay you back). But if you decide not to hold the bond until it matures, you can actually sell the bond to another investor in a secondary market. Those bonds are valued based on supply and demand, and on prevailing interest rates. When interest rates go up, bond values generally go down.
For example, if you were to invest $10,000 in a 30-year US treasury bond on December 31st last year, the interest rate was 1.9%. This means you would lend the US Government $10,000 and they would pay you $190 in interest each year for 30 years. At the end of 30 years, they would pay you back $10,000. Now, the week of May 6th, new 30-year treasury bonds are being issued at 3.23% interest. If you decided you wanted to sell your 1.9% bond to someone else, they would not want to pay you $10,000 for it when they can get a new bond paying 3.23%. Therefore, you would need to discount the bond and sell it to them for only around $5,900 to make the $190 in interest they would get be equal to the same 3.23% they could get on a new bond.
The Federal Reserve has already said they plan to increase interest rates several times this year to help curb inflation. Because of that, this had made bond values continue to fall and we expect that volatility will continue in the near future.
Now, the history has shown that even when stocks and bonds have suffered short-term, they have tended to bounce back at some point in future. Of course, past performance never guarantees future results. It is important to remember that market volatility is both natural and expected.
We tailor our clients’ investment portfolios based on their goals, risk tolerance levels, and time horizon so that they are positioned to navigate through various market cycles to try and achieve their personal goals. If you have more questions about how it may impact your personal financial situation, please contact your financial advisor for more information.