Tracy A. from Cincinnati, OH asks: Good morning, Mitch, I noticed that all of the bond holdings in my portfolio performed pretty poorly last year. And I’ve read that if interest rates go up, bonds go down. Are they worth holding on to for 2022?
Mitch’s Response:
Thanks for writing. I think you are generally right that interest rates are likely to tick higher in 2022, which could put some downward pressure on bond prices. Minutes from the Fed’s December 14-15 meeting, published on January 5, 2022, make it clear the Fed is more urgently addressing price pressures: “participants generally noted that…it may become warranted to increase the federal funds rate sooner or at a faster pace than participants had earlier anticipated.”
We’ve been watching Treasury yields moving higher in the past few weeks, as the marketplace anticipates tighter central bank policy. Higher yields have led to suboptimal returns in areas of the bond market – in 2021, U.S. Treasuries fell -4% and investment-grade bonds fell -1%.
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In my view, it depends on what purpose your bond holdings are serving in your portfolio. If the bonds are there as a means to generate passive income, then Treasuries may not be the best option. There are other types of bonds, like municipals and certain corporate bonds, that could generate better yield in a portfolio. For those with more growth-oriented goals, dividend-paying stocks and preferred stocks could also be worth exploring.
If your bond holdings are in your portfolio as a diversification strategy, in an effort to reduce risk and create a ‘smoother’ ride over time, then I may not be as quick to recommend ditching bonds in 2022. We cannot expect bonds to appreciate at the same time as stocks, since the entire point is that they are generally negatively correlated. When one zigs, the other zags, which is what creates that volatility cushion in investment portfolios. There was a period in early 2020 when there was a positive stock-bond correlation, but that appears to have been a temporary phenomenon.
Finally, while there is a likelihood that the Federal Reserve will be raising interest rates in 2022, there is always the possibility that some other unexpected or unanticipated crisis causes them to change course. In other words, rising interest rates in 2022 are not assured – in fact, since that’s the outcome everyone is expecting, I would not be surprised if something different happened.
The bottom line, in my view, is that some bond exposure can be good for an investor who wants diversification and a modest income. Those bonds do not necessarily have to be U.S. Treasuries, however. In my view, there are better areas of the bond market to look at right now, such as in municipals and quality corporate bonds. So, are you prepared for market changes that could come as a result of rising interest rates? Especially for those nearing retirement, we want to be sure you’re on the right track! There are common mistakes that we have seen investors make with their portfolios that can be avoided. To give you more insight into how to avoid these mistakes, we recommend reading our guide, “8 Retirement Mistakes to Avoid.” This guide dives deeper into the following mistakes:
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