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Oct 17

A year of pain for bonds. Here’s why you shouldn’t panic

Reading Time: 4 mins

Bonds are sometimes associated with risk-averse investors. They’re less volatile than other asset classes, and they typically have an inverse relationship with stocks and shares.

Yet 2022 has been a year like no other for the bond market. Even though equities have struggled this year, bonds have also taken a huge hit.

Just last week, yields on 20 and 30-year Government bonds rose above 5%. While yields have since fallen a tad, they’re still way above where they stood at the start of the year. So is now the time to dump bonds before prices fall further? Or is it wise to sit tight?

Keep on reading for all the details or click on a link to head straight to a section…

what are government bonds?

Government bonds, also known as ‘gilts’ in the UK, are issued by HM Treasury.

If you buy a Government bond, you’re effectively lending your money to the state. In return, you can expect to receive a ‘coupon payment’, which refers to the annual interest rate that’s paid on your bond.

Importantly, when yields on Government bonds rise, prices fall. When yields fall, the opposite happens. (Take a look at this article to discover why this happens).

Government bonds are considered ‘low-risk’

Government bonds are considered a safe, low-risk asset class as the state cannot go bankrupt. In other words, the Government will always be able to repay its debts in some form (even if it has to ask the Bank of England to print more of it)!

Because of this fact, holding a hefty chunk of bonds in your portfolio is typically regarded as a good way of protecting your investment from stock market volatility. A large reason for this is because when stocks fall, bond prices usually rise. This is because when stocks and shares slide, investors typically gravitate towards safer asset classes.

If you’re a moderate risk investor, you may have a typical 60/40 portfolio. That’s 60% in equities, and 40% in bonds. This is also a popular allocation for a number of private pension funds. So even if you don’t directly hold bonds yourself, falling bond prices may still impact you.

what has happened to bond prices this year?

Bond prices have tanked in 2022 (so far). Rising bond yields have largely been driven by the UK’s bleak economic forecast, with investors demanding a greater return for the risk of buying Government debt.

Rising interest rates have also, understandably, impacted bond prices this year. That’s because when interest rates rise, bond yields must also rise in order to attract new investors (which harms prices). If yields didn’t rise amid rising interest rates, then nobody would buy them!

the ‘mini-budget’ impact

While bond prices have suffered throughout 2022, things really started to take a turn following the  ‘mini-budget’ on 23 September. Unfortunately for then-Chancellor, Kwasi Kwarteng, the Government’s pledges to cut taxes and increase borrowing sent markets into a panic.  Put simply, the market didn’t believe the Government could credibly finance the commitments it had just announced.

Because of this, the pound plummeted against the US dollar – reaching an all-time low at one point. Meanwhile, yields on 10-year Government bonds soared above 4%

The fallout was so big that the Bank of England pledged to temporary buy bonds in order to steady the market, and prevent financial turmoil.

While this intervention boosted bond prices in the short-term, it didn’t take long for things to continue heading south. Last week, yields on 20 and 30-year Government bonds rose above 5% for the first time since 2002.

Thankfully things have since improved somewhat for bond holders. On Monday 17 October, the new Chancellor, Jeremy Hunt, announced a near-reversal of the ‘mini-budget.’ This immediately boosted bond prices, lowering the cost of borrowing for the state.

On the afternoon of 17 October, yields on 20-year gilts fell to 4.43%, while 30-year gilts fell to 4.34%. Despite this much-needed rally, bond yields are still almost four times higher compared with the beginning of the year.

should you sell your bonds?

If your portfolio has suffered this year, you may be tempted to offload your lowest performing assets. If you’ve a typical 60/40 portfolio, it’s very possible that your bond allocation has fallen more than your allocation of stocks and shares.

Yet before you dump your Government bonds it’s important to reassess the reasons why you purchased them in the first place. If you purchased bonds – or a balanced fund – because you wanted some protection against large falls in a stuttering stock market, then there isn’t much of a reason for you to offload bonds. That’s because bonds can still cushion your portfolio if the stock market slides in future.

Just because this hasn’t really been the case this year, the rules of investing haven’t changed. It’s also worth knowing that because bond yields have risen this year, over time, these bonds should now be less volatile going forward. This can reward bond holders in the long-term.

Remember, investing in hindsight is easy. Just because an asset class has suffered in the past doesn’t mean it will continue to do so.

For more on investing and choosing a suitable allocation within your personal risk profile, take a look at our article: How to create your own investing strategy in 5 simple steps.

And, if you want to stay up to date with all the latest market news, make sure you sign up for the fortnightly MoneyMagpie Investing Newsletter.

Disclaimer: MoneyMagpie is not a licensed financial advisor and therefore information found here including opinions, commentary, suggestions or strategies are for informational, entertainment or educational purposes only. This should not be considered as financial advice. Anyone thinking of investing should conduct their own due diligence.

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