Why is my bond index funds losing money?
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.
Because bond funds do not have a defined maturity date, and the investor chooses when to purchase and when to sell, as prices fluctuate due to interest rate changes and other factors, it is possible that an investor may receive less principal back than initially invested.
If interest rates go up, your bond fund will decrease in value. However, the higher interest rates will provide higher dividends. Eventually, the higher dividends make up for the initial loss of value. The length of time this takes is the duration of the fund.
The bond market is forward-looking and long-term Treasury yields typically decline once investors believe that rate cuts are coming.
As for fixed income, we expect a strong bounce-back year to play out over the course of 2024. When bond yields are high, the income earned is often enough to offset most price fluctuations. In fact, for the 10-year Treasury to deliver a negative return in 2024, the yield would have to rise to 5.3 percent.
And we believe bonds will continue to play a valuable role in offsetting stock losses over the long term. "Diversification benefits are back," said Sara Devereux, global head of Vanguard Fixed Income Group. "2022 was a highly unusual year. Over the long term, bonds continue to be a great diversifier to equity stress."
Why interest rates affect 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.
“Yields are fairly high now, and high-quality bonds that you hold to maturity are safe investments,” he said. Mr. Pozen added that well-diversified investment-grade bond funds make sense now, too, for prudent investors who are prepared to hold them for at least three years.
As with all investments, it is possible to lose money in an index fund, but if you invest in an index fund and hold it over the long-term, it is likely that your investment will increase in value over time.
The disadvantages of bond funds include higher management fees, the uncertainty created with tax bills, and exposure to interest rate changes.
How long will it take for bond funds to recover?
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.
Key central bank rates and bond yields remain high globally and are likely to remain elevated well into 2024 before retreating. Further, the chance of higher policy rates from here is slim; the potential for rates to decline is much higher.
Why did the Treasury bond market crash in 2022 and 2023? Interest rates and the price of bonds have an inverse relationship. As interest rates go up, the market value (price) of bonds declines. When the Federal Reserve raises the federal funds rate, it can cause the bond market to crash.
| 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 |
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.
Ultimately, holding bonds in a portfolio can help with diversification. Often, portfolio solutions (investments made up of carefully selected and managed mutual funds and/or exchange-traded funds) will include a fixed income component depending on how much risk you're comfortable with or when you will need your money.
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.
Call risk is the likelihood that a bond's term will be cut short by the issuer if interest rates fall. Default risk is the chance that the issuer will be unable to meet its financial obligations. Inflation risk is the possibility that inflation will erode the value of a fixed-price bond issue.
Investing in bond index funds can be one way to increase your exposure to safer, low-fee securities. But you may also encounter some hidden risks. Bond funds that invest heavily in government-backed securities, for example, may be highly volatile in a high interest rate environment.
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.
Is it better to buy bonds or bond funds?
There's no one right answer—bonds or bond funds—for every investor. The decision often comes down to the amount you have to invest, the preference for a professional manager, and the need for a predictable value at maturity.
Bond ETFs are set to have their best year since 2020. Amid a slowing economy, when inflation is cooling and interest rates are steady or falling, the top-performing bond ETFs will likely be those with a combination of longer maturities and investment grade or higher credit quality.
| Best Short-Term Bond Index Funds | Ticker | Return % |
|---|---|---|
| Fidelity Short-Term Bond Index | FNSOX | 1.49 |
| iShares 1-5 Year Inv Grade Corp Bond ETF | IGSB | 2.38 |
| SPDR Portfolio ST Corp Bond ETF | SPSB | 2.17 |
| Vanguard ST Corp Bond ETF | VCSH | 2.29 |
What is the timeline for your investment? If you're looking to make a long-term investment, then index funds may be a good option. But if you don't have the time or patience to wait out the market fluctuations, then purchasing individual stocks might be more suitable for your needs.
- Vanguard S&P 500 ETF (VOO 1.0%) ...
- Vanguard High Dividend Yield ETF (VYM -0.2%) ...
- Vanguard Real Estate ETF (VNQ 0.05%) ...
- iShares Core S&P Total U.S. Stock Market ETF (ITOT 0.97%) ...
- Consumer Staples Select Sector SPDR Fund (XLP -0.21%)
