Bonds are issued by corporations, the Treasury, federal agencies and state and local governments. Bonds are a means for the issuer to borrow money on which they pay interest.
Unlike with stocks, investors in bonds have no ownership interest in the issuer; they are simply lending them money. Besides the interest paid, investors in bonds can realize a gain or a loss based on the price movement in bonds. The price of bonds in the secondary market fluctuates inversely with the direction of interest rates.
Bonds can be purchased directly from the issuer when offered, and can be bought and sold in the secondary market. Additionally, there are mutual funds and ETFs that invest in bonds. These funds offer professionally managed portfolios of bonds.
Holding bonds versus trading them
If you buy a bond and hold it until maturity, you will receive the face value of the bond when redeemed plus any interest payments during the holding period. Interest is generally paid semi-annually. If you buy a bond on the secondary market, you will receive the face value of the bond at maturity regardless of how much you paid for the bond.
Bonds can be traded as well. When trading bonds, investors are focused on the potential movement in the bond’s price. The direction of interest rates is the prime factor in the direction of the price, but other factors such as the bond’s rating by various agencies and the time to maturity can also play a role.
- If held to maturity, investors benefit from regular interest payments and do not have to worry about price fluctuations.
- Bonds generally are lower risk and vary less in price than stocks. This can help offset the volatility in stocks.
- Bond prices will decline during periods of rising interest rates.
- Bonds will generally underperform during periods of high inflation.
Bond Performance in 2022
Bond performance in 2022 was among the worst in decades. The bond market faced a number of headwinds including:
- The highest levels of inflation in years.
- High interest rates as the Fed continued to raise rates to combat inflation.
- More restrictive monetary policy from the Fed.
- A slowing economy.
While the rise in interest rates hurt prices for holders of existing bonds and investors in bond mutual funds and ETFs, rising rates led to higher yields on newly issued bonds in 2022. Additionally, rising rates served to push down prices of bonds in the secondary market offering opportunities for investors to purchase bonds at a reduced price. Over time, this could result in a profit should they sell after rates have dropped, in addition to being able to collect interest payments while they wait.
The Outlook for Bonds in 2023
How bonds perform in 2023 will depend on a number of factors, including what the Fed does in terms of continued interest rate hikes during the year. By some measures, inflation has stopped its rise and is subsiding, which is a positive for bond investors.
One factor in bonds’ favor is that bond yields are now at a level that can help retirees seeking income support a 4% retirement withdrawal rate.
Beyond this, both individual bonds and bond funds could benefit if interest rates stabilize or decline. The latter could occur if the Fed decides that inflation is under control.
One potential challenge for bonds is the recession that some are predicting. A recession could put a damper on the performance of corporate bonds.
Many experts feel that 2023 will bring many opportunities for bond investors. They feel that the Fed is nearing the end of their rate hikes and tightening monetary policy. A recession could certainly put a halt to both Fed tactics. This would aid bonds significantly. As rates level off or decline, this might prompt investors to reach out to the longer end of the yield curve. Higher rates here could add value for investors looking for a more stable source of income over time.
Consult your Wedbush financial advisor to discuss the role that bonds can play in your portfolio. They can advise as to the types of bonds that are right for you and the right level of allocation to bonds for your portfolio in light of your risk tolerance and financial goals.
These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information presented is not intended to constitute an investment recommendation for, or advice to, any specific person. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. The information in these materials may change at any time and without notice.