In conclusion
Rising interest rates are not what bond investors would, in an ideal world, prefer. During the 29-year declining rate environment from 1982-2010, the five bond funds whose example I looked to produced predictably better annual performance than they had in the rising rate environment – 7.85% annually versus 4.15% annually – and the real returns for bonds were significantly higher from 1980-2010 than from 1950-1980.
What lessons should you take away from my research?
- History is on the side of bond investors, even in a rising rate environment;
- The low historical variability of returns for bonds means past bear markets were much easier on bond buyers than is commonly thought;
- Interest rate increases have unfolded gradually;
- Since interest rate increases have been slow, rising interest income will outweigh the loss in principal value;
- Maturities should be shortened in a rising rate environment;
- Bond funds may perform better than individual bonds during rising rates, because of the ability to reinvest funds at progressively higher interest rates;
- Diversification across bond issuers, sectors and maturities is vital during a period of rising rates; and
- Avoid experimenting with untested products or strategies during rising rates.
For the diversified bond fund, bond index or balanced fund investor, rising interest rates are simply not the looming catastrophe they have been made out to be.