Slaughter is a strong word.
But that’s how this year has felt for “safe” assets. Fixed income—the part of the investment portfolio that is usually considered safer than riskier assets like stocks—has had one of its worst years ever.
At the end of September, a financial columnist for the NY Times wrote, “This year is the most devastating period for bonds since at least 1926, the numbers show. And, in the estimation of one bond maven, 2022 is shaping up to be the worst year for bonds since reliable record-keeping began in the late 18th century.”1
Global bonds—not just the US—has had one its worst years in decades. According to T. Rowe Price using the Bloomberg Global Aggregate Bond Index, “global fixed income investors have not endured a rout like this since official data began in 1990. It has even surpassed the 10% drawdown witnessed during the global financial crisis.”2
Keep in mind, there are all kinds of fixed income: corporate bonds, municipal bonds, treasury bonds, high-yield bonds, in the country or out of the country, etc. One of the safest of the safe when it comes to bonds are those backed by the US Treasury. Shockingly, as the chart above reveals, they have spent a lot of time this year underperforming the technology company heavy Nasdaq stock index.
Underperforming the Nasdaq? Really?
That’s not what Grandma signed up for.
A brief explanation of how this happens is by understanding how bonds work. When interest rates go up, bond prices go down. And vice-versa. News flash: interest rates have gone up—fast.
A rising rate environment means that new bonds of the same type pay more and are worth more than the old bonds of the same type in a low-interest rate environment. For example, if Company or Government XYZ offers Carlos a bond today that pays 6% interest, the bond of XYZ that his neighbor Sam owns which only pays 3% is worth a lot less.
The length of the bond also comes into play. Changes in interest rates affect the price of the bond more for the ones that mature many years in the future than the bonds that mature next year. Of course, there are a number of other factors that influence the prices of bonds, but this is a brief explanation for the uninitiated.
Let’s get back to that slippery word “safe” though. It’s important to understand what “safe” means. Safe does not mean the price won’t go down along the way to maturity. It refers to the creditworthiness of the issuer. The US government’s ability to give you your money back at maturity is considered risk-free in comparison to your best friend Johnny’s bonds that he issues via his lemonade stand on the corner of Main Street. As long as the individual bond in the company or government you own is still “in business” when your bond matures, you’ll get your money back.
But defining safety in this way doesn’t really resonate when a retired family member's bond prices on their monthly statement is down ugly.
Remember too: while individual bonds have callable or maturity dates where investors may get their original investment back, mutual funds and ETFs don’t have that feature (though they have other benefits like diversification).
Does this mean you should abandon bonds in an investment portfolio? Not necessarily. Does that mean you should add fixed income exposure in your portfolio? Potentially. Challenging environments like this may bring buying opportunities.
Like any investment, you should know what you own and why you own it.
This year is a good reminder and wake-up call about that four-letter word: R-I-S-K, especially as it relates to investments that are considered safe. No one is that concerned about risk/safety/reward when most asset classes are all going up. Declines demand a brutal education in risk management. Do you know what your risk profile is? Are you in “risk” assets or “safe” ones?
And bring grandma and grandpa.