New bonds pay more and old bonds are worth less.
This is the plain English version of what’s going on in the bond market right now. Translated to finance-speak, bond yields are on the rise while returns are steadily falling. For investors, it’s a good time to hold and an even better time to buy – but you may want to rethink plans for an immediate sale.
Here’s what you should know.
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What’s Going On in the Bond Market?
There are three things to understand about the current bond market.
First, the yield on newly-issued bonds has remained surprisingly strong. While many investors expected this to be a short bump, the rates on long-term Treasury bonds continue to climb. That, in turn, has pushed up the yield on corporate bonds, since virtually all forms of lending use Treasury bonds as their benchmark rate.
Currently, yields on Aaa corporate bonds have passed 5.1%.
Second, this has pushed down the value of older bonds. The more new bonds pay, the less investors pay to buy previously-issued assets. After all, say that you have a bond paying 3% interest per year. If investors can choose between your bond and a newly-issued asset paying 5%, they’ll pay more for the stronger investment – and less for yours.
Third, and finally, analysts expect this to remain the state of play for the foreseeable future. As Morningstar wrote, “higher for longer” has become a watchword on Wall Street.
A financial advisor can help you navigate changes in your portfolio.
Why Are Rates High?
There are several reasons for higher interest rates, but the biggest two are inflation and government debt.
When the government needs to borrow money, it issues bonds that it then sells to a wide variety of institutions and investors. As Goldman Sachs wrote on the subject: The more bonds a government tries to sell, the more interest it has to pay to attract new lenders.
But this process doesn’t happen in a vacuum. Interest rates also relate to economic strength and inflation. In a strong economy, investors have many different places to put their money. The safety of a bond isn’t in-and-of itself enough to attract investment. Investors want returns that can compete with an attractive equity market, which can push rates higher.
At the same time, the Federal Reserve has stated its intention to keeps rates high for now. Those rates set the floor price for borrowing in both private and public institutions, which drives up rates for bonds across the market. And, as if this weren’t enough, inflation alone is enough to push up bond yields as investors demand interest rates that can keep up with the price of money.
While some economists remain concerned about a near-term recession, high government debt and inflationary concerns are likely to remain for some time.
Compare different investment options with a financial advisor, who can provide personalized advice and planning.
What Should You Do?
Now may be a good time to lock down high-yield bonds in the pursuit of income investing. Rates haven’t been this high since 2011, and they will eventually go back down. But if you buy a 20- or 30-year bond, it will remain in your portfolio for decades ticking away at that 5% yield. Or, in the alternative, you could take advantage of the low returns, buying up lower-rate bonds cheap. This isn’t as strong a move for income investors, but those 3% or 4% bonds are good assets currently being sold at a discount.
For investors who currently own bonds, now is probably a good time to sit still.
Returns are down, which means that you would likely have to accept a loss to sell off any of your older bonds. Those assets simply aren’t as strong as what private companies and the Treasury are currently offering. Unless you have a strong reason to do so, it may be wise not to sell right now and wait for the market to cycle back around.
For advice tailored to your own specific needs and circumstances, talk to a financial advisor today.
In Brief
A combination of inflation, a strong economy and high debt have led to the highest bond yields since 2011. For investors, that makes now a good time to buy new assets and hold on to the ones they already have.
Bond Investing Tips
- A financial advisor can help you build a comprehensive retirement plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Maybe we’ve sold you on the idea of investing in bonds. While exposed to inflation, they’re a good security and income asset for your portfolio, so certainly don’t overlook this asset class. Here’s what you need to know.
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