Why hold bonds now?

There are plenty of headlines about the Federal Reserve planning to raise interest rates this year. Bond prices move in the opposite direction of interest rates, so rising rates mean falling bond prices. Doesn’t that mean that bonds are almost certainly going to lose value this year? And does that mean you shouldn’t be invested in bonds?

Actually, that?simple view doesn’t give the complete picture. The Fed has been signaling interest rate increases for some time now. Bond markets have already reacted to those expectations. Bond buyers and sellers don’t wait until the interest rate increases?actually happen. Once they expect interest rates to rise, right away they adjust the prices at which they’re willing to buy or sell. Wouldn’t you do the same? That’s why bond prices have already?fallen by about 5% so far this year, even though the Fed has barely started its expected series of gradual rate increases.?

From here, bond prices will react to either changes in expectations or interest rate surprises. If the Fed increases interest rates slower than currently expected, then bond prices can?actually increase, providing a positive return. Also,?keep in mind that as bond funds reinvest their maturing bonds into new bonds, the newer bonds will pay higher yields over time. The bottom line is that bonds are not at all predestined to lose value for the rest of the year.

Finally, remember that bonds are in your portfolio to provide diversification. They can provide a very strong buffer against stock market losses that may occur at any time and without advance warning. In addition, some economic crises bring about a “flight to safety,” where bond prices can go up regardless of what’s happening with interest rates.?

The end result?of thinking more clearly about how markets work is that you shouldn’t sell out of bonds now. Market timing doesn’t work for stocks, and it doesn’t work for bonds either. If bonds fit into your overall diversified portfolio last year, they should still do so today.