Bonds are supposed to be dull, churning out income with soothing regularity. But many bond investors have been having a distressing experience lately.
For several years, bond prices have been lurching like an out-of-control roller coaster, and holders of bond mutual funds and exchange-traded funds have endured an exceptionally wrenching ride.
Bond prices and yields, or interest rates, move in opposite directions, and because rates have fallen this autumn, there’s actually some good news for bond investors. For the year so far, the investment-grade bond benchmark, the Bloomberg U.S. Aggregate Bond Index, has returned more than 7 percent, including dividends.
But that performance didn’t come from the Steady-Eddie reliability that bond mavens once cherished. It’s just that the roller coaster swerved, for a while, into placid territory, an abrupt turnaround from the steep decline induced by President Trump’s tariffs in April. I doubt it will last.
To be clear, even in the midst of severe price swings, you won’t be harmed financially if you just hold onto high-quality, individual investment-grade bonds to maturity. Individual bondholders generally get back all the money invested in high-quality bonds, plus any interest payments, when the bonds’ term is done.
But if you own bond mutual funds or exchange-traded funds — as do most individual U.S. investors — then fluctuating bond prices can be a psychic burden, even if you don’t sell the funds. That’s because funds are required to report shifting prices every day.
What’s more, oscillating fund prices roughly approximate what owners of individual bonds would experience if they chose to sell their bonds. They would be exposed to the whims of the bond market, which has sometimes been merciless.
Getting Queasy
It’s been easy to lose major parts of your investments in bonds over certain periods during the last several years, starting with the mayhem of the runaway inflation of 2022. The Bloomberg U.S. Aggregate, the most widely used benchmark for investment-grade bonds, including Treasuries, lost more than 13 percent that year, including reinvested interest.
It was much worse for 20- and 30-year U.S. Treasury bonds, which may have seemed to represent the pinnacle of safety. In 2022, the iShares 20+ Year Treasury Bond E.T.F., which tracks and holds long-term Treasuries, lost more than 31 percent of its value, about 13 percentage points worse than the negative return of the S&P 500.
For bondholders, the pain persists. In the five years through Oct. 20, the core Bloomberg U.S. Aggregate was down 0.1 percent, annualized — a small loss, but compare that to the 16 percent annualized gain of the S&P 500. For longer-term Treasuries over the same period, the performance was horrendous: The iShares 20+ Treasury Bond E.T.F. lost 7.7 percent, annualized, for a 33 percent cumulative loss, according to FactSet.
In other words, if you had held that long-term Treasury fund over these five years — or held equivalent individual Treasuries and sold them at the wrong time — the value of your bonds could have declined by one third.
Another startling downturn in bond prices occurred in April. “People were getting a little queasy,” President Trump said on April 9, explaining why — at least temporarily — he moderated his tariff policy. “The bond market is very tricky,” he said.
It’s also immensely powerful — paradoxically so, for an institution whose central appeal is the implicit promise that its marquee attraction will be boringly safe.
Caveats and Concerns
The U.S. bond market isn’t merely a place for parking money and collecting interest. One corner of it, the Treasury market, is arguably the core engine of the entire financial universe, around which everything else revolves.
If you’re an American consumer, the interest on your credit cards, mortgages, and car and student loans is influenced by the bond market. If you’re an investor, the entire stock market is priced using bond market rates as a measuring stick. And for small businesses, giant corporations and governments around the world, the Treasury market has provided the standard against which everything else may be calibrated.
But these days there are problems galore, at nearly every level of the market, starting at its core, U.S. Treasuries. The government funding shutdown is harming the economy but even if it ends soon, it is likely to contribute to the erosion of the U.S. government’s reputation.
After myriad shutdowns and debt ceiling crises, the U.S. government bond rating is no longer first-rate in the eyes of any of the major credit-rating agencies. The so-called risk-free Treasury has been tarnished.
“Obviously, you can’t, with a straight face, say it is risk free,” Aswath Damodaran, an N.Y.U. finance professor, said in an interview.
The gradual loss of Treasuries’ pristine status has increased the yields that must be paid in the marketplace. Those higher yields are adding to the burden of future taxpayers, and increasing the costs for businesses and consumers.
From bondholders’ standpoint, the paramount problem may be that the government is spending far more than it is taking in, and the federal debt as a percentage of gross domestic product has reached levels unseen since the end of World War II. The Trump tariffs are bringing in revenue, but not enough to deflate the swelling budget deficit.
At the same time, the administration has been hammering the Federal Reserve to lower the short-term interest rates that the central bank controls, and has threatened its independence. The possibility of another burst of high inflation can’t be dismissed.
If inflation takes off again, most bond prices will decline as yields rise. To protect against that risk in the United States, Treasury inflation-protected bonds (TIPS) are one answer, though they have not performed well in noninflationary periods.
But bonds tend to underperform when prices rise rapidly. And the threat of higher inflation is weighing on the overall bond market.
Core Holdings
Yet for many people, high-quality bonds remain essential investments. Even for investors outside the United States, U.S. Treasuries are still a central holding.
The latest official government statistics — less current than they might be because of the government shutdown — showed that foreign ownership of U.S. Treasuries reached new highs in July. What increased specifically was ownership of Treasury bills — short-term securities with a duration of a year or less — and not longer-term Treasuries.
That may be because declining prices of longer-term Treasuries over the last several years, along with the weakening dollar, are giving some international investors reason for concern about long-term holdings in the United States.
Domestic investors may want to be cautious, too. I’ve shortened the duration of my own holdings in the last year, choosing ease of access and secure values in a period of unfolding crises. But I still own plenty of investment-grade bonds of many varieties through bond funds, and keep my shorter-term fixed-income instruments — Treasury bills and the like — mainly in government money market funds.
I prefer owning funds to individual bonds because bond funds, particularly low-cost index funds, provide broad diversification, and are inexpensive and easy to use. Over long periods, bond funds and high-quality individual bonds tend to converge in value. If you don’t need to sell the funds or individual bonds, the fluctuations aren’t a big problem, as long as you can stomach declining prices.
I hold the bond funds primarily to buffer the risk of my global stock index funds, which fluctuate more wildly than the bond funds. Data provided by Morningstar makes the case.
Morningstar used returns for the S&P 500 and its predecessors, as well as for 10-year Treasury notes, from 1928 through 2023. It found that adding Treasuries to a stock portfolio sharply lowered the chances of overall portfolio losses over periods of 10 years or less.
In a period fraught with risk, it still makes sense to hold safer assets, and that still means bonds. But don’t kid yourself. The roller coaster is bound to start lurching again. Today, even government bonds aren’t entirely safe.
Jeff Sommer writes Strategies, a weekly column on markets, finance and the economy.
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