Really, I can lose money in bonds?
Bonds in most portfolios are purchased for income and stability. What bond investors commonly do not expect is a return in bonds. That is what has happened over the last few years thanks to a low interest rate environment. Low interest rates favor equities, therefore a strong stock market. After all, you can earn more income holding a dividend stock than a bond based on what yields are currently at.
However, a year-to-date return in the bond market has finally turned negative. This actually started happening in May of this year. Prices of bonds have dropped from their extended high prices while their yields have increased. The global economy is improving with the U.S. economy being the strong point in the recovery resulting in investors demanding a greater return on their investments. A greater return in bonds is a higher interest rate. A higher interest rate pushes current prices down on low coupon bonds. These lower prices on our existing bonds result in a negative return. This negative return looks like a loss because your portfolio use to be $200,000 in January and now it is $190,000 and you only hold bonds. What happened? I thought bonds were safe and I would not lose any money if I hold bonds!
Most bonds are safe but subject to current economic price swings. The bonds held in your portfolio may be down on a year to date basis but most likely not down from when you purchased them. Price is only one factor. Your income being paid should not change based on current bond market value because the coupon you paid for is stable. I like to call this for what it is… A paper loss. Just like when your bonds were returning 4.5% or 5% last year; that was a paper gain. You were never going to actually receive that 4.5% or 5% return unless you sold the bond at the higher premium price. You are now not going to sell the same bonds at a lower price. You are holding your bonds until they mature, getting your principal value back to reinvest while still collecting the stable income from your bonds.
The bond market is more challenging than the stock market. Bonds have credit ratings, economic conditions and duration risk that impact their price. I truly believe you need to know what you are investing in and how each investment will impact your overall portfolio and goal. This will assist you with knowing why you should not sell in a declining price trend.
Good luck investing in your portfolio.