Investors in fixed-income securities are experiencing disappointing returns lately as interest rates rise in response to 40-year high inflation. The Federal Reserve’s Open Market Committee (FOMC) has been behind the eight-ball throughout the pandemic with its overly accommodative monetary policies concurrent with wave after wave of massive government fiscal stimulus which injected trillions of dollars into the economy. The FOMC repeatedly stated its opinion that inflation pressures would prove to be transitory once those dollars circulated throughout the economy. Finally, on 12/01/21 it threw in the towel announcing it was retiring the word transitory as ongoing supply chain disruptions and labor shortages proved to be among the influences the fed had not adequately anticipated.
Because bond prices move in the opposite direction of interest rates, bonds’ total returns have fallen as market rates move up from historical lows. Total return measures the sum of income and price changes, up or down. Given low yields and recent negative performance, why would anyone want to include bonds in their long-term investment portfolio? It’s because most investors cannot tolerate the volatility of an all-equity portfolio and leaving money in cash for extended durations at near-zero yields makes little sense. Even with recent negative returns, bonds can help temper equities’ greater volatility.
While bond prices will fluctuate during the interim period, if held to maturity, the investor should receive the rate of return locked in when the bond was purchased. For the millions of investors holding short-intermediate term bonds, once those securities mature, they can look forward to higher yields from the reinvested proceeds. A little pain now can result in greater gains later.
Bonds can be the liquid asset class that allows investors to remain committed to their equity holdings. Without that reduced volatility, many investors will bail out of their equities or halt their monthly investing at the point of greatest opportunity, that being when share prices are down. By owning fixed-income securities, investors are willing to accept a lower long-term return in exchange for staying fully invested in their equities. Bonds truly can be the tie that binds investors to a lifetime of growth that comes from ownership in a collection of the world’s greatest companies.