Understanding Bonds in a High-Interest Rate Environment

Understanding Bonds in a High-Interest Rate Environment

Why Bond Investors Shouldn’t Panic—and Might Even See
Opportunity

For many investors—especially retirees—bonds have long been seen as less
volatile, lower risk part of a portfolio. They provide steady income and
typically help offset the volatility of stocks. But over the last couple of
years, bondholders have experienced something rare: losses. And in some cases,
significant ones.

So, what’s going on? And more importantly—what should you do
about it?

Why Bond Prices Go Down When Rates Go Up

Let’s start with the basics. When you buy a bond, you’re
essentially lending money to a government, municipality, or corporation. In
return, they pay you interest (called the “coupon”) and then repay
your principal at the end of the bond’s term (the “maturity date”).

Here’s the key: as interest rates rise, existing bonds
with lower coupons become less attractive to new investors. To compete with
new, higher-yielding bonds, the price of existing bonds must fall. This is
known as an inverse relationship between bond prices and interest rates.

This relationship has always existed—but it hasn’t been
front and center until recently. That’s because from 2009 to 2021, interest
rates stayed near historic lows. Now, the Federal Reserve has raised rates
aggressively in an attempt to combat inflation—moving from near zero to over 5.25%
in under two years.

The Worst Bond Year in Modern History

In 2022, the bond market had its worst year in decades. The
Bloomberg U.S. Aggregate Bond Index—which tracks a broad mix of government and
corporate bonds—fell 13%, marking its biggest decline since the index
was created.

To put that in perspective, bonds rarely experience
full-year losses at all—much less double-digit drops. This shook many
conservative investors who were used to seeing bonds as the “boring” part of
their portfolio.

But history tells us something important: sharp declines in
the bond market tend to be followed by stronger-than-average returns. Just like
stocks, bonds can bounce back.

Is It Time to Give Up on Bonds?

Not at all. In fact, for the first time in over a decade,
bonds are paying investors meaningful interest again.

If you’re buying a U.S. Treasury bond or a high-quality
corporate bond today, you might be earning 4% to 6% or more, depending
on the term and risk level. And for those nearing or in retirement, that kind
of typically steady income—without the daily drama of the stock market—can be a
valuable part of your financial plan.

Also, if interest rates begin to decline in the next 12 to
24 months (as many economists believe they will), bond prices could actually
rise, helping to offset recent losses.

Bond Funds vs. Individual Bonds: What’s the Difference?

Many investors own bonds through mutual funds or
exchange-traded funds (ETFs). These can be a great way to diversify, but they
don’t have a maturity date like individual bonds. That means their prices can
be more sensitive to interest rate movements, and they won’t “recover” in the
same way a bond held to maturity will.

However, bond fund managers are constantly reinvesting
proceeds into new, higher-yielding bonds, which over time can help improve the
fund’s income potential. Understanding the fund’s duration—a measure of how
much it might fluctuate as rates change—is key.

If you’re uncomfortable with price swings in bond funds,
owning individual bonds and holding them to maturity might offer you more confidence.

Where Do Bonds Fit Now?

Here’s the good news: for patient investors, bonds may offer
the most compelling value they’ve had in over 15 years. Whether it’s U.S.
Treasuries, high-quality corporate bonds, or tax-free municipal bonds for those
in higher tax brackets, today’s environment allows you to earn attractive income
without taking equity-level risk.

Short-term bond ladders, conservative bond funds, and
customized portfolios of individual bonds can all play a role in a sound
retirement strategy. The key is aligning your fixed income investments with
your time horizon, income needs, and comfort with volatility.

If you’re not sure how rising interest rates have impacted
your portfolio—or whether your bonds are helping or hurting your plan—let’s
review it together. You can schedule a time with me at www.calendly.com/kent-pendleton/60min
or call my office. You don’t need to navigate this alone.

Kent Pendleton, AAMS®

Financial Advisor, RJFS

Pendle Hill Advisors LLC

14375 Liberty St, Ste 109 | Montgomery, TX 77356

T 936-297-8267

Kent.Pendleton@raymondjames.com | www.raymondjames.com/pendlehilladvisors

Securities offered through
Raymond James Financial Services, Inc. Member FINRA/SIPC. Investment advisory
services are offered through Raymond James Financial Services Advisors, Inc.
Pendle Hill Advisors is not registered broker dealers and is independent of
Raymond James Financial Services.

Opinions expressed in the attached article are those of the
author/speaker and are not necessarily those of Raymond James. All opinions are
as of this date and are subject to change without notice. Investing involves
risk and you may incur a profit or loss regardless of strategy selected,
including diversification and asset allocation. Prior to making an investment
decision, please consult with your financial advisor about your individual
situation. Every investor’s situation is unique and you should consider your
investment goals, risk tolerance and time horizon before making any investment.
The forgoing is not a recommendation to buy or sell any individual security or
any combination of securities. The information contained in this report does
not purport to be a complete description of the securities, markets, or
developments referred to in this material.

Investments in municipal securities may
not be appropriate for all investors, particularly those who do not stand to
benefit from the tax status of the investment. Municipal bond interest is not
subject to federal income tax but may be subject to AMT, state or local taxes.

There are special risks associated with investing with bonds such as interest
rate risk, market risk, call risk, prepayment risk, credit risk, reinvestment
risk, and unique tax consequences. To learn more about these risks and the
suitability of these bonds for you, please contact our office.

Bonds are subject to risk factors including:
1) Default Risk – the risk that the issuer of the bond might default on its
obligation
2) Rating Downgrade – the risk that a rating agency lowers a debt issuer’s bond
rating
3) Reinvestment Risk – the risk that a bond might mature when interest rates
fall, forcing the investor to accept lower rates of interest (this includes the
risk of early redemption when a company calls its bonds before maturity)
4) Interest Rate Risk – this is the risk that bond prices tend to fall as
interest rates rise.
5) Liquidity Risk – the risk that a creditor may not be able to liquidate the
bond before maturity.