Over the past 35 years, the Barclays Aggregate Bond Index has returned on average 7.8% per year. Those are equity-like returns with considerably lower volatility.
In 1981, the yield on 10 year US Treasuries was just shy of 16%, they now yield below 2%:
That’s one helluva run.
That being said, this type of move in the bond market will not be repeated over the next 35 years. So why are we behaving like it will?
If you buy a bond and hold it to maturity, you know that your returns will be your yield-to-maturity (barring default, etc…). Even in the current low yield environment, you can buy a 10 year US Treasury note and know that if you hold it to maturity 10 years from now, your average yearly return will be 1.87%.
However, this is not the case with bond mutual funds or ETFs.
As the US Fed resumes its rate hiking cycle, retail investors everywhere are going start to understand a concept that they could pretty much ignore over the past number of years: interest rate risk. Practically speaking this will take the form of bond portfolios losing their value as rates rise and bond prices fall.
If you own individual bonds, rising rates mean that you incur the opportunity cost of holding paper that has maximum upside. However, if you own a bond ETF, especially one with long duration, the value of your holdings can fall considerably.
Here’s a good run down from Forbes:
LINK: Bond ETFs
Do we hold bond funds in our portfolios? Yes, we do. But we also have exposure to the assets that will have to rise in order for the Fed to continue to raise rates – especially in conservative portfolios.