You are probably aware that interest rates have increased substantially over the last several months. Since the beginning of the year, the 10-year treasury bond yield has increased from 1.52% to 2.85% as of this writing. That’s an 87.5% increase in less than four months. Similarly, 30-year mortgage rates have increased since the beginning of the year from 3.11% to 5.0% as of this writing. That is a 60.7% increase.
The rapid increase in rates has created a challenging bond market so far this year. When interest rates rise, existing bond prices go down. You might wonder why that happens when bonds mature at par value. Let me explain using an example: if you own a bond yielding 1.5% and new bonds are available yielding 3%, you will need to discount your 1.5% bond to sell it. All bonds in a portfolio get re-priced every day. As a result, no matter if you are selling your bonds or not, they show up on your statement priced as if they were being sold that day.
The good news for bond investors is that interest rates are higher. Even though current bond prices are down, bonds will be yielding a higher rate moving forward. For example, a $10,000 treasury bond at the end of 2021 would have paid out an annual interest payment of approximately $152 compared to a current payout of approximately $285. Over time, the increase in yields will offset the decrease in the current bond prices and eventually the total return on bond portfolios will be higher than if interest rates had not increased.
None of us enjoy getting investment statements showing us that our accounts are down. Especially when those accounts are designed to be more conservative. So, remember that if you can hold your bonds through this adjustment period, the increased yield on your bond portfolio will be a benefit to you in the long run.
As always, if you have questions about your investment portfolio, please contact us and we can discuss your specific situation.