In September 2022, millions of investors watched their "safe" bond funds drop 30%.
At the same time their stocks were crashing.
They'd been told bonds were the sensible part of the portfolio… the smart thing to do.
Yet it didn't work out that way.
To understand why, you need to know the difference between owning a bond and owning a bond fund… because they are fundamentally different animals wearing the same name.
When you own a bond directly, it's simple. You lend a government or company a fixed amount of money. They pay you interest. At the end of the term, you get your money back. If you hold the bond to maturity, the swings in between are irrelevant to you as your return is locked in the day you buy.
A bond fund owns hundreds of bonds at once, but it never matures. So the fund keeps rolling bonds over indefinitely, and the price fluctuates every single day based on where interest rates happen to be sitting.
This is the part that bites people…
When interest rates rise, the value of existing bonds falls. Own a bond directly and you can just wait it out. Own a fund and you can't because it never matures, so the paper loss just sits there staring at you.
That's exactly what happened in 2022. The Federal Reserve hiked rates aggressively to fight inflation, and long-term bond funds like TLT (which tracks US government bonds with 20+ years until they mature) lost roughly a third of their value. Stocks were also down sharply that year and so the portfolio shock absorber absorbed nothing.
Geopolitical shocks make this worse.
Like when oil prices spike (as they tend to during Middle East conflicts)… bond investors worry about inflation… and inflation is the enemy of bonds.
So instead of rallying when stocks fall, bonds can fall right alongside them. The classic safety net develops holes at exactly the wrong moment.
The classic "60/40 portfolio" was supposed to mean you'd never lose much in a downturn because one side would cushion the other. That assumption was built on decades of falling interest rates.
But in a world where rates rise, or where government debt is ballooning, the math changes.
Now, none of this means bond funds are useless. TLT in particular has been relatively stable for the past three years, which actually makes it a decent candidate for the Wheel Strategy. That's a very specific use case though, and a completely different job description.
The mistake most investors make is treating a bond fund like a bond. One is a loan with a fixed end date. The other is a price that moves around based on whatever central bankers said at their last press conference.
Which brings me to tomorrow…
I'm running a free live training called Calm Amongst the Chaos which is specifically designed for investors who are watching markets get choppy and want a strategy that generates income whether things go up, down or sideways.
It's on Zoom at 11AM ET tomorrow, and it's completely free.
If 2022 taught us anything, it's that the traditional "just hold stocks and bonds and hope for the best" approach has some serious gaps.
Tomorrow I'll show you a better way.
Reserve your spot here: https://us02web.zoom.us/webinar/register/WN_m8X-SNKLT4Sa_bOcUrVmhA
Oliver