Why Are My Bond Funds Losing Value?

All investments offer a balance between risk and potential return. Historically, the average returns from bond investments have been lower and more stable than the average returns from stocks. In general bonds are considered less risky than stocks. Bonds balance the risk of owning stock. More conservative portfolios will contain more bonds.

If you have been conservative, and you look at the results from the last few months, you are likely to wonder why you’ve been losing money after picking what you considered a safe route. The surprise of the last few months has been that a “conservative” approach turned into the strategy most prone to losses. The safest bonds, U.S. Treasury bonds, have been losers. There is an inverse relationship between interest rates and bond prices. When interest rates rise, bond prices fall; conversely, when rates decline bond prices rise. Bonds with a longer time to maturity carry a greater risk. There have been slight increases in interest rates this year. There is also anticipation that rates will increase more. This anticipation causes reaction.

In a bond mutual fund, when interest rates rise many shareholders in the fund will liquidate their shares, to avoid further losses. When this occurs, the fund manager may be forced to sell bonds prematurely in order to raise enough cash to meet the redemption requests. This action and reaction causes the prices of the bond fund to go down further.

What should you do? Don’t panic! If interest rates rise, it creates opportunity to buy bonds with a higher yield. The value of your bond fund will increase as the fund has the opportunity to invest in higher interest rate bonds. If you’re concerned about future increases in interest rates which could lead to further declines in bond prices, one strategy to minimize losses is to own shorter maturity bonds. Shorter-term bonds tend to fluctuate less as rates rise.

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