The Investment Scientist

The Silver Lining of Bond Funds Going Down in Value

Posted on: May 11, 2022

If you bought a bond fund three months ago, you may have seen your fund go down about 10% in value! What the heck is going on? Aren’t bond funds supposed to be safe? In today’s newsletter, I will explain what’s going on, I will explain why you should still consider your bond funds safe, and I will even give you some hidden upsides of bond funds going down in value.

What’s Going On?
Last month we saw interest rates rallying. Bonds are essentially fixed future promised payments.  The current value of a bond is the sum of all fixed payments discounted by interest rates. When interest rates go up, it stands to reason that, applying the mathematical formula, the current value of the bond will  go down. This mathematical logic applies to all bond funds. 

Is My Money Safe?
Yes! You will still get all your interest payments and the principle back eventually. You will not lose money as long as you don’t panic and sell your bond funds, which would turn the mathematical loss into an actual economic loss. 

What are the Hidden Upsides?
First, you will earn more interest over time. How does that happen? A bond fund usually holds many bonds with different maturities. As a bond matures, the fund will get the principle back, and can then invest the principle into other bonds that pay the higher prevailing interest rate.

Second, you can take advantage of tax-loss harvesting. If you are in a high-income bracket, this is especially valuable. You may sell bond fund A and buy a similar bond fund, B. By doing that, you are essentially holding the same collection of bonds, but you have now recorded an accounting loss that you can use as a deduction when you do your taxes! 

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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