Why are my bond funds losing money?
Interest rate changes are the primary culprit when bond exchange-traded funds (ETFs) lose value. As interest rates rise, the prices of existing bonds fall, which impacts the value of the ETFs holding these assets.
Bond prices decline when interest rates rise, when the issuer experiences a negative credit event, or as market liquidity dries up. Inflation can also erode the returns on bonds, as well as taxes or regulatory changes.
We expect bond yields to decline in line with falling inflation and slower economic growth, but uncertainty about the Federal Reserve's policy moves will likely be a source of volatility. Nonetheless, we are optimistic that fixed income will deliver positive returns in 2024.
Most bonds pay a fixed interest rate that becomes more attractive if interest rates fall, driving up demand and the price of the bond. Conversely, if interest rates rise, investors will no longer prefer the lower fixed interest rate paid by a bond, resulting in a decline in its price.
“Although some volatility may continue, we believe interest rates have peaked,” predicts Kathy Jones, chief fixed income strategist at the Schwab Center for Financial Research. “We expect lower Treasury yields and positive returns for investors in 2024.”
Likewise, you may want to hold on to I bonds issued between May and October 2023. Those I bonds have a fixed rate of 0.9%, which is the highest fixed rate in 16 years. No matter what happens to inflation in the future, you'll lock in that rate for as long as you own the bonds.
In line with the outlook from other investment providers, the firm is forecasting a 5.7% gain in 2024 for U.S. investment-grade bonds, versus 4.9% last year and 2.3% in 2022. (All figures are nominal.)
Bond funds staged a fourth-quarter comeback in 2023. Through late October, the Morningstar US Core Bond Index, a proxy for the broad fixed-income market, was on pace for a third-consecutive year of losses as uncertainty around a hard or soft landing lingered and interest-rate volatility persisted.
The table on the right shows that bond prices often recover within 8 to 12 months. Unnerved investors that are selling their bond funds risk missing out when bond returns recover. It is important to acknowledge that some of those strong recoveries were helped by bond yields that were higher than they are today.
The short answer is bonds tend to be less volatile than stocks and often perform better during recessions than other financial assets.
What is the outlook for bond funds in 2023?
We expect generally good performance during the second half of the year, although volatility may increase, especially for high-yield bonds. Corporate bond investments generally performed well during the first half of the year.
2 When the market consensus is that a rate increase is right around the corner, it's time to go to market. Unless you are set on holding your bonds until maturity despite the upcoming availability of more lucrative options, a looming interest rate hike should be a clear sell signal.
Yields on high-quality bonds have risen back to around their historically normal levels. Higher yields enable bonds to once again play their traditional role as sources of reliable, low-risk income for investors who buy and hold them to maturity.
We think bonds will prove their worth again as a source of income and a diversifier to equities. There should be more opportunities ahead, even if investors need to traverse some moguls in the economy.
Bond prices move in inverse fashion to interest rates, reflecting an important bond investing consideration known as interest rate risk. If bond yields decline, the value of bonds already on the market move higher. If bond yields rise, existing bonds lose value.
The final two months of 2023 witnessed impressive surges in both the equity and bond markets, with increases of approximately 15% and 8%, respectively. These gains contributed to year-to-date returns of 25% and 5% for the equity and bond markets, respectively.
| Face Value | Purchase Amount | 30-Year Value (Purchased May 1990) |
|---|---|---|
| $50 Bond | $100 | $207.36 |
| $100 Bond | $200 | $414.72 |
| $500 Bond | $400 | $1,036.80 |
| $1,000 Bond | $800 | $2,073.60 |
Including bonds in your investment mix makes sense even when interest rates may be rising. Bonds' interest component, a key aspect of total return, can help cushion price declines resulting from increasing interest rates.
Top four schemes in the category offered over 7%. ICICI Prudential Corporate Bond Fund, the topper in the category, offered 7.60% in 2023. Aditya Birla Sun Life Corporate Bond Fund offered 7.29%. HDFC Corporate Bond Fund gave 7.20%.
- UnitedHealth Group Incorporated (NYSE:UNH)
- JPMorgan Chase & Co. (NYSE:JPM)
- Advanced Micro Devices, Inc. (NASDAQ:AMD)
- Adobe Inc. (NASDAQ:ADBE)
- Salesforce, Inc. (NYSE:CRM)
What is the market outlook for 2024?
The Economy
Economic growth is projected to slow in 2024 amid increased unemployment and lower inflation. CBO expects the Federal Reserve to respond by reducing interest rates, starting in the middle of the calendar year. In CBO's projections, economic growth rebounds in 2025 and then moderates in later years.
The top picks for 2024, chosen for their stability, income potential and expert management, include Dodge & Cox Income Fund (DODIX), iShares Core U.S. Aggregate Bond ETF (AGG), Vanguard Total Bond Market ETF (BND), Pimco Long Duration Total Return (PLRIX), and American Funds Bond Fund of America (ABNFX).
The 4.30% composite rate for I bonds issued from May 2023 through October 2023 applies for the first six months after the issue date. The composite rate combines a 0.90% fixed rate of return with the 3.38% annualized rate of inflation as measured by the Consumer Price Index for all Urban Consumers (CPI-U).
2022 was the worst year on record for bonds, according to Edward McQuarrie, an investment historian and professor emeritus at Santa Clara University. That's largely due to the Federal Reserve raising interest rates aggressively, which clobbered bond prices, especially those for long-term bonds.
Bond prices have an inverse relationship with interest rates. This means that when interest rates go up, bond prices go down and when interest rates go down, bond prices go up.
