When I hear the phrases “market risk” or “market volatility”, the first thing that comes to my mind is stocks. Risk and volatility are inherent in equity investing and most understand that.
Since its inception, the S&P 500 has returned roughly 9-10% per year. However, in order to receive this great return, you would have had to endure some extremely difficult times….
2007-2009: down 57% over 1.4 years
1973-1974: down 48% over 1.7 years
1930-1932: down 83% over 2.1 years
1929: down 44% over 67 days
These dramatic swings are the cost of doing business and are to be expected from time to time.
What many investors aren’t accustomed to, is Risk and Volatility creeping into their bond portfolios. Unfortunately, this has been a reality for many over the past 3 months.
The reason why? Interest Rates….
The 10-year Treasury, which we will use as the proxy for rates, has moved from 1.35% to over 2%, for nearly a 40% increase! While these levels of interest rates are still historically low, the velocity in which rates have moved has been impactful to many parts of the economy and portfolios.
As a quick reminder, the longer the duration of your bonds, the higher their sensitivity is to interest rate movements. Bond prices and interest rates are inversely correlated. When rates go up, your current bonds lose value. On the flip side, when rates go down, your bond appreciates in value. For anyone under 40,
This amount of volatility is certainly extreme for fixed income; however, interest rates are still incredibly low from a historical perspective. As you can imagine, the short-term movement in rates is incredibly hard to predict. Depending upon on how current economic and geopolitical issues shake out, I wouldn’t be surprised to see rates go in either direction. From a long-term perspective, we do believe that rates have to increase to more normalized levels (10yr 3-4%). This would mean pain in the interim for duration sensitive bonds.
How to combat this? Stay short to intermediate on the duration side of things and truly know what type of bonds you own. As you can see, there are risks associated with investing no matter the asset class. It’s our belief that fixed income in your portfolio should act as the ballast when equities struggle. By taking too much risk in one direction or another can alter many planning conversations. This is truly a complex topic and one that takes time to fully grasp. As always Ed and I are here to answer any and all questions.
Thanks,
Frank