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A Ray of Hope

A Ray of Hope

| October 17, 2022

You’ve got to find silver linings where you can in times like these.

We’re in the midst of the worst bond market bruising since data was accurately tracked starting in 1976. Some estimates project that 2022’s plunge in global Treasuries is among the four worst since...wait for it...the year 1700! While those are staggering stats, there’s a silver lining you must know about regarding how the fixed-income market works.

U.S. Bond Market: Worst Year on Record. Down 15%.

Source: J.P. Morgan Asset Management

Global Government Bonds: Estimated to be the 4th Worst Year Since 1700

Source: Bank of America Global Research

A little math lesson is warranted here: When interest rates go up, bond prices decline. Here’s the logic behind that relationship: Since new market interest rates are more desirable, older, lower-yielding bonds must drop in price to be as attractive to traders.

What so many investors fail to recognize, though, is that when they see their bonds down 5% or 10% due to higher market interest rates, those bonds will likely appreciate back to “par value” of 100 cents on the dollar as they approach maturity. The assumption is that the bond issuer is able to repay all of its periodic interest payments and the final return of principal when the bond comes due.

Still, that price reversion to par value is not so obvious if you’re not deep into investing. While you will probably see unrealized losses on your bonds, perhaps 5% to 10%, those prices will appreciate back to 100 cents on the dollar as they near maturity over the coming years.

And here’s the kicker – proceeds from the bonds coming due (and interest payments along the way) will be reinvested at new, higher interest rates.

How much better is the fixed-income investing environment now? The chart below illustrates that U.S. Treasuries sport a rate nearly three times the median yield of the past decade. You can even step out onto the risk curve and buy a low-cost high-quality corporate bond fund paying almost 6%. Individuals and couples in a high tax bracket might look to purchase municipal bonds for their preferential tax treatment – “tax equivalent yields” are upwards of 7% in some cases!

Bond Market Rates Look Much Better These Days

Source: J.P. Morgan Asset Management

The Bottom Line

While there’s temporary pain in how your bonds are marked today, it‘s not a permanent impairment of capital. There’s a great long-term benefit of higher market interest rates as we can now finally earn a decent yield on bonds.