What was the worst year for bond funds?
It's one of the reasons they complement each other in financial portfolios — bonds can provide stability and balance out the volatility of stocks. And yet, that didn't happen in 2022, the worst year for bonds on record in a century.
2022 was the worst year on record for bonds, according to Edward McQuarrie, an investment historian and professor emeritus at Santa Clara University.
Interest rate changes are the primary culprit when bond exchange-traded funds (ETFs) lose value. As interest rates rise, the prices of existing bonds fall, which impacts the value of the ETFs holding these assets.
Key central bank rates and bond yields remain high globally and are likely to remain elevated well into 2024 before retreating. Further, the chance of higher policy rates from here is slim; the potential for rates to decline is much higher.
In 2022, the bond market suffered its worst year on record, as the Federal Reserve started raising interest rates aggressively to fight high inflation.
We expect bond yields to decline in line with falling inflation and slower economic growth, but uncertainty about the Federal Reserve's policy moves will likely be a source of volatility. Nonetheless, we are optimistic that fixed income will deliver positive returns in 2024.
Yields on high-quality bonds have risen back to around their historically normal levels. Higher yields enable bonds to once again play their traditional role as sources of reliable, low-risk income for investors who buy and hold them to maturity.
Most investments in debt, from corporate bonds to mortgage-backed securities, carry some degree of default risk. The investor accepts the risk that the borrower will be unable to keep up the interest payments or return the principal invested.
Bonds are generally considered a less-risky complement to the volatility of stocks in an investment portfolio. U.S. Treasurys, and specifically Treasury bills and Treasury notes, are the benchmark for a nearly risk-free investment if held to maturity.
The disadvantages of bond funds include higher management fees, the uncertainty created with tax bills, and exposure to interest rate changes.
Where are bonds headed in 2024?
Strong demand should support bonds in 2024
Many who left the bond market when yields were rising should return to lock in today's higher yields. The Bloomberg U.S. Aggregate Index currently has a yield of around 4.6%.
Unless you are set on holding your bonds until maturity despite the upcoming availability of more lucrative options, a looming interest rate hike should be a clear sell signal.
Including bonds in your investment mix makes sense even when interest rates may be rising. Bonds' interest component, a key aspect of total return, can help cushion price declines resulting from increasing interest rates.
You should also consider your risk tolerance. While both CDs and bonds are generally safe investments, both carry their own risk factors. CDs face inflation risk, while bonds face interest rate risk. Investing in a mixture of both can help hedge your investments.
The table on the right shows that bond prices often recover within 8 to 12 months. Unnerved investors that are selling their bond funds risk missing out when bond returns recover. It is important to acknowledge that some of those strong recoveries were helped by bond yields that were higher than they are today.
The bond market has had its own crash over the last two years. And to some, including me, it was not a big surprise, because bonds can only be expected to return what they yield over long periods of time, and when yields fell to zero (even negative), the expected return on bonds should have been expected to be…
And we believe bonds will continue to play a valuable role in offsetting stock losses over the long term. "Diversification benefits are back," said Sara Devereux, global head of Vanguard Fixed Income Group. "2022 was a highly unusual year. Over the long term, bonds continue to be a great diversifier to equity stress."
Given the numerous reasons a company's business can decline, stocks are typically riskier than bonds. However, with that higher risk can come higher returns.
Unlike individual bonds, most bond funds do not have a maturity date, so holding them until maturity to avoid losses caused by price volatility is not possible.
Vanguard's active fixed income team believes emerging markets (EM) bonds could outperform much of the rest of the fixed income market in 2024 because of the likelihood of declining global interest rates, the current yield premium over U.S. investment-grade bonds, and a longer duration profile than U.S. high yield.
Do bonds lose money in a recession?
Can you lose money on bonds during a recession? Yes, while bonds are generally safer, there are risks involved. These include interest rate risk, reinvestment risk, and the risk of the bond issuer defaulting on their debt obligations.
In line with the outlook from other investment providers, the firm is forecasting a 5.7% gain in 2024 for U.S. investment-grade bonds, versus 4.9% last year and 2.3% in 2022. (All figures are nominal.)
Face Value | Purchase Amount | 30-Year Value (Purchased May 1990) |
---|---|---|
$50 Bond | $100 | $207.36 |
$100 Bond | $200 | $414.72 |
$500 Bond | $400 | $1,036.80 |
$1,000 Bond | $800 | $2,073.60 |
Bond prices move in inverse fashion to interest rates, reflecting an important bond investing consideration known as interest rate risk. If bond yields decline, the value of bonds already on the market move higher. If bond yields rise, existing bonds lose value.
The short answer is bonds tend to be less volatile than stocks and often perform better during recessions than other financial assets.
References
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