September 19, 2022- While the Federal Reserve continues to raise interest rates to combat inflation, the value of bond holdings has fallen in response, which has many investors wondering if they need to get out of bonds. For long-term investors, this view is short-sighted and ignores the benefit of higher rates going forward, which is the main reason to stay invested in bonds.

As an investor with a portfolio that includes stocks and bonds, you are likely accustomed to seeing the value of your stock holdings fluctuate significantly with the market, while bond values typically stay more consistent. This year has been an exception, as swift declines in bond prices have rivaled those of stock. U.S. Treasuries, which are the global fixed-income benchmark, have declined over 11% year-to-date, with prices falling as yields climb.

This drop in bond values has many pundits saying that the typical stock and bond portfolio is dead. However, it is important to note the long-term benefits of higher rates.

For bond investors, the focus should be on total returns, which are made up of price return and income return. When interest rates rise, as we are seeing now, price return decreases while income return increases. For long-term investors, the long-term total return matters more than the short-term fluctuation in price. Vanguard’s recent article, Why You Shouldn’t Abandon Bonds, provides the chart below showing that, in the long-term, the greatest return for bonds is from income return, not price return.

For the long-term bond investor, the price return component of total returns decreases over time. For stocks, the price return is a much larger component of total returns. The bear markets of the early 2000s are a prime example of this, as many refer to this period as “The Lost Decade,” when the total annualized return of the S&P 500 was negative.

Conversely, when looking at a bond bear market like the 1970s, when inflation and interest rates were rising rapidly, investors who remained disciplined and continued to reinvest their interest income nearly doubled their capital from 1976 to 1983. This is a prime example of the merit in looking past the short-term losses and focusing on the upside of higher interest rates going forward.

To read more about long-term investing in the stock market, see the article by Dimensional Fund Advisors, Worried About Stocks – Why Long-Term Investing is Crucial.