Listen as Vanguard experts explain why the return on your bond portfolio can be positive even with higher rates.

With interest rates on the rise, some investors are concerned that their bonds will decline in value. Listen in as Vanguard experts Bryan Lewis, CFP®, and Kevin DiCiurcio, CFA, explain why the return on your bond portfolio can be positive even with higher rates.

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Notes:
  • All investing is subject to risk, including the possible loss of the money you invest.  There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. Diversification does not ensure a profit or protect against a loss.
  • Bond funds are subject to the risk that an issuer will fail to make payment on time, and the bond prices will decline because of rising interest rates or negative perceptions of an issue’s ability to make payments.
  • Coupon is the interest rate paid by a bond. In most cases, it won’t change after the bond is issued.
  • Duration is a rough measure of how much a bond’s price is likely to fluctuate against a change in interest rates. The higher the duration number, the more sensitive a bond investment will be to changes in interest rates.
  • Yield is a measure of interest that takes into account the bond’s fluctuating changes in value.
  • This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.
  • Advice services are provided by Vanguard Advisers, Inc., a registered investment advisor.

© 2017 The Vanguard Group, Inc. All rights reserved.

TRANSCRIPT

 

Emily Farrell: Joe in Spring, Texas, he asked, “If rising interest rates hurt bond prices, then why should I buy bonds when interest rates are increasing?” All right, pretty simple, Kevin.

Kevin DiCiurcio: It’s simple, but the ultimate paradox, I think, for fixed income investors. As fixed income investors, we really do want higher yields. Higher yields mean more income, higher potential expected returns in the future; but the process from getting to low yields to high yields means negative price movements and negative price returns for the bonds that you already hold. So how do you reconcile that?

And, you know, we do it in a couple ways. We certainly hear about the concerns on rising rates very frequently. So we think of it in a few different ways. The first is that the yield curve that I described already contains information about the future market expectations for future interest rates. And when the yield curve is upward sloping, it tells you that there’s already a general degree of rate rising that is expected by the market. So, you know, if you’re trying to get fancy and time the market and say, “I’m going to get short duration or lower my interest rate exposure buying shorter bonds,” you know, shorter bonds will outperform longer bonds only when rates rise faster than expected. Longer-term bonds will outperform shorters when rates don’t rise as fast as expected.

It sounds very tough to do in practice, and it is. And if I’m being completely honest, the future interest rate movements that are priced into the yield curve have a very poor predictive power in the future as well. It’s just another reason why we think timing things is very difficult.

I started my career, actually, in fixed income in 2009; and I can recall at least three other occasions where financial news market commentators are telling us that we’re going to get the sustained rise in interest rates. And each time, yeah, rates rose a little bit, and they kind of settled lower. So it just demonstrates how really it is difficult to time these sorts of things. So we really encourage clients that have intermediate-term time horizons to really focus on the total returns of your bond portfolio, and the total returns include both the price return and also the income return.

As interest rates rise, you will experience short-term capital losses. The reason you experience short-term losses is because as new bonds are issued at those higher coupons or higher rates, the bonds you hold to be attractive in the marketplace, the price has to decline. You’re holding a lower coupon; the price has to decline so that the yields are comparable.

And so as, you know, you take the short-term capital hit, and as higher coupons start replacing the lower coupons in your portfolio, over time those coupon returns, those income returns start offsetting those short-term price movements. So we see over five-, six-year horizons, you can really look through those capital losses and focus on the positive higher income that you’re generating.

Important information

All investing is subject to risk, including the possible loss of the money you invest.  There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. Diversification does not ensure a profit or protect against a loss.

Bond funds are subject to the risk that an issuer will fail to make payment on time, and the bond prices will decline because of rising interest rates or negative perceptions of an issue’s ability to make payments.

Coupon is the interest rate paid by a bond. In most cases, it won’t change after the bond is issued.

Duration is a rough measure of how much a bond’s price is likely to fluctuate against a change in interest rates. The higher the duration number, the more sensitive a bond investment will be to changes in interest rates.

Yield is a measure of interest that takes into account the bond’s fluctuating changes in value.

This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.

Advice services are provided by Vanguard Advisers, Inc., a registered investment advisor.

© 2017 The Vanguard Group, Inc. All rights reserved.