Bonds are in the red – What should a conservative investor do?
Traditionally, investors who are risk averse allocate the majority of their portfolios to bonds. If you check a recent brokerage statement, most bonds appear to have lost money. The yield of bonds has been rising, with the price reacting conversely, showing losses. For example, according to the Barclays Aggregate Index published in the Wall Street Journal as of August 17, 2018, the lowest yield in the past 52 weeks is 2.38% with a high of 3.43% producing a year to date total return loss of -1.10%. At the same time, stocks and equity mutual funds have been increasing in price and value, showing gains.
What should a conservative investor do?
Each person must assess their own situation, however, gaining an understanding of bonds can help answer the question.
When large companies need to borrow money to expand their businesses, they issue bonds that pay a specific interest rate, and mature in a set period of time. In the simplest terms, bonds are like bank CD’s that pay interest and mature, without the FDIC insurance, and based on the strength on the company that issues them. Since there is no guarantee (FDIC insurance) bonds typically pay more interest than bank CD’s to account for the risk.
In my own practice, an individual financial plan is the road map we follow to determine the allocation of stocks, equity mutual funds, bonds and bond mutual funds.
When individual bonds are part of the plan, we assess the time horizon of when the bond matures, and the fixed interest rate it pays. If it is acceptable, the bond is purchased with the intention to hold it until maturity.
Brokerage statements are required to report what your investments are worth if you sold them on the statement date. With regard to a bond, if the interest rate it pays is less than the current market interest rate (rising interest rates), the value on the statement would be less than the original cost, thus showing an unrealized loss.
Even though the statement value appears lower, the reason for the original purchase has not changed and neither has the interest rate it pays, nor the return of principle at maturity.
Was there really a loss?
In conclusion, bonds have a place in the conservative portion of a portfolio, even in a rising interest rate environment.
* In general, bond prices rise when interest rates fall, and vice versa. This effect is usually more pronounced for longer-term securities. You may have a gain or loss if you sell a bond prior to its maturity date.