Why are bond prices down? Should you be buying bonds now?

Bonds are very safe investments - they lower risk and volatility but underperform stocks in the long run. The stock market has an annualized return of 10% over last 50 years compared to long-term treasury bond which has an annualized return of 5%. But there are certain market conditions where investing in bonds becomes attractive because they help reduce the downside risk by acting as a good hedge against stocks while offering good returns.

The kind of returns you can expect on your bonds depends on the interest rates and time to maturity. Let's first try to understand how these factors influence bond prices?

Imagine you loan your friend Adam $1,000. He agrees to pay you back in 1 year with monthly interest payments at a 5% interest rate, earning you $50 during the year. But then your friend Tom starts offering $1,000 loans at a 6% interest rate. Your loan is now less attractive in comparison that if you were to sell it to someone—give them the rights to collect the interest payments, you will have to discount it to the face value ($1000 - 1% of 1000 = $990) to account for that extra 1% of return.

Bonds prices and interest rates have an inverse relationship. If interest rates increase, previously issued bonds lose value because an investor can buy new bonds with the same maturity date and receive a higher yield (and income stream).

As you can see in the image above, one-year Treasury bills (short-term bonds issued by the government) are currently yielding 4.7%, which is much higher than the 20 yr Treasury bonds (long-term bonds) purchased in Jan at around 2% rate. In case of a rising inflationary regime, newer short term T-bills get a preference over older longer term T-bonds. This naturally leads to the prices for US 20 Yr Treasury Bond falling. iShares 20+ Year Treasury Bond ETF (TLT) index which tracks the results of U.S. Treasury bonds with remaining maturities greater than twenty years is down over 30% YTD as shown in the image below.

Saay balances your portfolio to include short-term-bonds when interest rates are rising and long-term-bonds when interest rates are cut. Sign up for our waitlist here.