"Why Do I Own These Fixed Income Assets Anyway?"
If you're staring at your portfolio today and wondering, “Why do I own these bonds?” You’re not alone. In a well-diversified portfolio, fixed income assets serve two essential purposes: generating recurring income and mitigating risk. But in 2022, bonds didn’t behave like the safe- haven they had been for decades.
The aggregate bond index dropped nearly 13%, while the S&P 500 fell around 18%. Double trouble. So, what gives?
The Interest Rate Shock of 2022
Bonds have an inverse relationship with interest rates. When rates rise, bond prices fall. In 2022, inflation surged to 9.1%, driven by strong consumer demand, constrained supply chains, and geopolitical tensions, most notably the Russian invasion of Ukraine. As communities reopened post-COVID, the supply-demand imbalance intensified.
To combat inflation, the Federal Reserve raised the fed funds rate at a pace not seen since the 1980s. Starting near zero, rates climbed rapidly: 0.25% in March, 0.50% in May, and by the end of 2023, we hit a range of 5.25–5.5%.
Credit card rates soared past 25%, auto loans reached high single digits, and home equity lines jumped from 3–4% to similar levels. Suddenly, short-term savings vehicles offered over 5% in daily liquidity, making long-term bonds paying 4.5% look unattractive. Investors were disincentivized to lock up capital for a decade at lower yields. Bond values dropped like a rock.
But the Income Stayed
Despite falling prices, high-quality bonds, government, corporate, and agency backed securities continued to pay consistent interest. For example, a $10,000 bond with a 4% coupon still delivered $400 annually, even if its market value declined. As long as the issuer remained financially sound, that income stream was intact.
Savvy investors saw opportunity. With some bonds trading at 80–85 cents on the dollar, yields became compelling. That same $10,000 bond now offered a current yield of 5% and a yield to maturity closer to 6.78%. Hold it to maturity, and you’d collect $400 annually plus the $2,000 gain when the bond returned to par.
Fast Forward to Today
Inflation has cooled significantly from its peak, and the economic outlook for 2025 is cautiously optimistic. Supply chains have stabilized, consumer resilience remains strong, and GDP growth is projected above 3%. While challenges persist, like tariffs and rising business costs, many companies have absorbed these without passing them on to consumers.
Meanwhile, bonds have quietly staged a comeback. Rates have declined, and those same 4% coupon bonds have appreciated in value. The aggregate bond index is up 7% year-to-date. As rates fall, bond prices rise. And if you’re in the camp expecting further rate cuts, bonds may still have room to run.
Why Bonds Still Matter
Bonds aren’t just about returns; they’re about balance. They provide:
- Recurring income for retirees or income-focused investors
- Diversification opportunities across credit quality, maturity, and issuer type
- A hedge against stock market downturns
Yes, they’ve been frustrating and even boring over the past five years. But when equities stumble, bonds can shine, especially when rates normalize.
A Word of Caution
Interest rates remain the biggest influence on bond performance. While market sentiment can cause short-term fluctuations, it’s the Fed’s policy that truly moves the needle. If rates rise again, bond values may face pressure. But if cuts continue, appreciation could follow.
As the saying goes: “Don’t fight the Fed.”
Final Thoughts
If you take one thing from this post, let it be this: explore whether fixed income assets belong in your portfolio. If you own bonds, ensure your allocation to bonds is appropriate for your risk objective and time horizon. They may not be flashy, but they’re foundational. And in times of uncertainty, having a plan, and a trusted advisor to help align your bond strategy with your goals, can make all the difference.
Because the worst outcomes happen when we’re unprepared. Your portfolio allocation should be ready for whatever comes next.