After a Terrible Year for Bonds, the Outlook Is Better

“Basically, it’s never been worse than the last year,” he said in an interview.

Bonds are loans made by investors who, in return, receive regular income, known as yield. Market yields have already risen appreciably.

Bond returns — in an actively traded portfolio of individual bonds or in a mutual fund or an exchange-traded fund — come from a combination of yield and price changes. When yields rise, bond prices fall, and vice versa. That’s fundamental bond math.

These price effects are much greater for bonds of longer maturity — more precisely, bonds of longer duration, an important measure of interest rate sensitivity. This means that the price of a 30-year Treasury bond will move much more than the price of a three-month Treasury bill in response to the same interest rate shift.

Think of it this way: When the market interest rate rises to 4 percent but you already own a security that pays you 3 percent in income, your security will lose some of its market value. For a security that will keep paying an inferior interest rate for 30 years, the loss is much greater.

This disparity is why the rising interest rates of the last year have been wonderful for short-term fixed-income investments and awful for those of longer term.

Consider a few numbers.

Through November, the leading bond index, the Bloomberg Aggregate, was down nearly 13 percent for the year. Long-term Treasury bonds were even worse for the period — down more than 26 percent for representative exchanged-traded funds that track that market, like the Vanguard Long-term Treasury E.T.F. and the iShares 20+ Bond Treasury E.T.F. By comparison, in the same period, the S&P 500 stock index, dividends included, was down 13 percent. In other words, bonds performed as badly as stocks, and longer-term bonds did even worse.

It’s a different story for short-term fixed-income investments. As I suggested would happen last spring, the Federal Reserve’s actions have driven up the income, or yield, that investors receive from money market funds and short-term bank certificates of deposit. In January, money market and C.D. yields were close to zero. Now they are in the 4 percent range for some money market funds, and approaching 4.5 percent for some C.D.s.


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