As of late August, the total return for the Bloomberg U.S. Aggregate Bond Index, the benchmark for investment-grade bonds, was down more than 10% for the year. Other bond indices are taking a beating, too.¹

Because stocks and bonds are not typically correlated, investors may be confused and frustrated that their bond holdings don’t seem to be providing a haven amid a bear market for stocks.

The underlying, indirect cause of the bond slump is inflation, fueled by economic recovery from the Covid-19 pandemic, supply-chain snarls, government stimulus, the war in Ukraine, and other factors. The more direct cause is the Federal Reserve, which has been aggressively hiking interest rates to fight inflation. Higher interest rates cause bond prices to fall: New bonds issued at higher interest rates make existing bonds at lower rates less attractive on the secondary market. Add to this the U.S. Treasury’s quantitative tightening—the government is buying fewer bonds—and investors wonder: Is it time to get out?²

Advisors can assist their clients by reminding them of the big picture, reinforcing the fundamental benefits of bonds, even in a year when few investments feel safe.

Bonds May Offer Income Stability and Mitigate Portfolio Risk 

Bonds, unlike equity investments, are loans with a set of specific obligations to the issuer over a set period. Bond investors essentially are lenders, with the defined benefits of interest payments and the repayment of principal. Government and investment-grade corporate bonds generally have a strong record of safety, and a steady stream of income has a stabilizing influence on investment portfolios regardless of market volatility. Some debt instruments, such as municipal bonds, offer the added benefit of tax-free interest payments at the federal and possibly state levels. Therefore, holding those bonds, even in a down market, can be better than selling at the worst possible time.

Bonds are Generally Less Volatile Than Stocks 

Tough as it is for bond prices these days, the stock market has fared worse: The S&P 500 was down as much at 24% from its highs earlier this year, and even after a rally, was down by 13.3% for the year as of late August. The tech-heavy Nasdaq Composite was down 20.75% in the same time frame, and the stock market overall was down 14.4%.³ In that light, the Bloomberg U.S. Aggregate Bond Index’s roughly 10% decline is less discouraging. Generally, the bond market is less vulnerable than stocks to wild swings on a daily or weekly basis. 

Bonds Offer Opportunity

While it can be frustrating to see current bond holdings drop in price, there is a parallel opportunity for new bond investments. Falling bond prices mean rising yields on debt already issued, and new bond issuances that debut at a time when the Fed is tightening offer higher interest rates. Every client has different needs, but for retirees or others for whom income and low risk to principal are paramount, holding existing bonds while perhaps adding new ones is a strategy worth considering—more so, certainly, than giving into anxiety, selling, and locking in losses.  

Moving in and out of positions tends to be costly. Research by DALBAR Inc. shows that untimely or excessive buying or selling is the primary cause⁴ that returns for investors—even in bull markets—typically trail broad market returns. For example, in the first half of last year, the gap in the return between investors and the S&P 500 was 2.11 percentage points.  

In good markets or bad, advisors serve their clients best by encouraging them to “Keep Calm and Remain Diversified.” This is especially true during periods of decline: Over the last 20 years, during down cycles, the average intra-year decline for the S&P 500 was 15.5 percent, while a diversified portfolio* saw an average drop of less than 9 percent.  

Bonds may not seem attractive currently, but they remain a key element of a balanced investment strategy, and they offer additional benefits such as stable cash flow and protection of capital. In tough times, those are benefits worth preserving.