When you view your statement this month, you will likely notice some decline in the value of your portfolio. When you dive into the details, you may be shocked to see that your supposedly “safe” bonds actually dropped in value.
After a little swearing, the first question you ask might be “Why?” Why did my bonds lose value, especially when I heard that interest rates went up last month? Shouldn’t higher interest be good?
I am going to stay away from the technical jargon and just focus on a common sense explanation. Let’s say you bought a ten year US Treasury bond paying 3% at some point in the past. You know that ten years from when you bought the bond, the government will return your principal, and you will have collected 3% annual interest along the way.
But along the way, interest rates changed. Let’s say the ten year rates went down from 3% to 2%. This means that someone could get a new ten year Treasury paying 2%, or they could buy your 3% Treasury bond from you. Since your bond pays 3%, you would expect a premium. Your 3% bond should be worth more than a 2% bond. Conversely, if rates went from 3% to 4%, why would anyone want your 3% bond when they can get a new one for 4%? Unless you sell at a discount; therefore your bond will be worth less.
Between May and June the ten year interest rate jumped a full percentage point (approximately from 1.6% to 2.6%). This rise in the interest rate probably caused your bonds to fall in value.
I hope this helps; next post we’ll discuss what to do about it.