Even Safe Bond Investments Falter as Markets Tumble

The stock market isn’t the only thing dropping. Bonds, which are supposed to be the safe part of every investor’s portfolio, have faltered, too.

In what’s been a rude awakening for some investors, bond funds have lost ground these past couple of weeks, unlike in past downturns for stocks. What’s different this time is that the same things undercutting stocks are hurting bond prices: worries about inflation and the possibility of much higher interest rates, AP reported.

Bond losses have been more modest than the setback for stocks, but more may be on the way. And swings in bond prices are likely to become more common than in recent years, when returns were unusually smooth, experts say.

Nevertheless, experts are sticking with the mantra that bonds will be safer than stocks and that investors can continue to count on them as a stabilizing force for their portfolios.

Ken Mahoney, president of Mahoney Asset Management, said he has been hearing from clients this week who were surprised by the struggles for bonds. “They kind of say, ‘I thought when stock prices go down, bonds go up?’” he said.

Instead, while stocks were dropping 10% from their record high, set on Jan. 26, the largest bond mutual fund lost 0.8% through Thursday.

The spark that sent markets tumbling was a report last week that showed wages in the US are rising faster than expected. That raised concerns that inflation may be on the way up, which could force the Federal Reserve to increase interest rates more quickly than expected.

When the Fed raises rates, bonds typically begin paying more in interest. That’s good for investors who buy those more lucrative, newly issued bonds. But the old bonds sitting in bond funds’ portfolios see their prices drop, because they suddenly look less attractive than the new ones.

Inflation, meanwhile, is one of the worst enemies for bond investors, because it dilutes the value of the fixed payments that bonds make. Even before the inflation worries flared, bond fund investors were jittery because the Fed has been slowly winding down the measures it took to stimulate the economy during the Great Recession. The Fed is raising short-term interest rates and reducing its large holdings of bonds.

Because of that, investors need to recalibrate their expectations for how steady bond funds can be, particularly after the unusually calm stretch that investors have enjoyed.