Written by: Miguel Biamon, Senior Fixed Income Portfolio Manager, NewSquare Capital
Fixed income has a reputation for being the “safe” side of investing. Many investors see bonds as the part of their portfolio that won’t lose money. The truth is more complex. Bonds can offer balance and income, but they carry their own kinds of risk, and understanding those risks is the first step toward using them effectively.
One of the biggest misconceptions I see is the belief that fixed income means zero risk. It’s true that high-quality bonds can offer more stability than equities, but “stability” doesn’t mean “immunity” from losses. When interest rates rise, bond prices fall.
The relationship is mathematical. If rates move up one percentage point, a bond portfolio with a four-year duration could see its market value drop roughly 4%. Duration is a measure of how sensitive a bond’s price is to interest rate changes.
Those price swings don’t always mean permanent losses. If you hold a bond to maturity and the issuer doesn’t default, you’ll still get your principal back. Selling before maturity, however, can lock in a realized loss if rates have risen. In 2022, for example, investment-grade bonds had their worst year on record as the Bloomberg U.S. Aggregate Bond Index fell about 13%, underscoring how interim price declines can be severe even in high-quality bonds.
Know what you own
Another distinction to understand is the difference between owning individual bonds and owning bond funds or ETFs. With an individual bond, you know your outcome from day one: what you paid, what you’ll earn, and when you’ll get your money back, assuming you hold it to maturity. A mutual fund or ETF works differently.
Most of these types of fixed income don't have a set maturity date, and the value can fluctuate based on what other investors in the fund are doing; heavy redemptions of mutual funds can force managers to sell into dislocated markets and can lead to capital-gains distributions.
An investor’s desire for higher yield can come with increased risk. In the years of near-zero interest rates, many investors reached for yield by taking on longer maturities or lower-quality bonds. When rates climbed, those same bonds dropped sharply in price. Treasury yields surged through 2022 as interest rates rose, creating a tough backdrop for long-duration securities. Lower-quality bonds can be less liquid, which can impact your ability to sell if needed.
An approach to fixed income investing that is favorable for many investors is a “laddered” approach, building a portfolio of bonds that mature at different times, typically from one to 10 years. As older bonds mature, proceeds can be reinvested at current yields. Over time, this approach can help manage interest-rate and reinvestment risks and keep cash flow steadier across rate environments.
How fixed income supports balance
Fixed income, for most investors, is meant to complement stocks. Bonds can help dampen volatility and generate income, particularly for investors who are closer to retirement or simply want more stability.
It’s also important to remember that stocks and bonds don’t always move inversely. In 2022, both markets fell. The S&P 500 dropped about 19% while the Bloomberg U.S. Aggregate declined around 13%. Stock-bond correlation can flip in inflationary shocks, which reduces diversification benefits over short windows of time.
The most successful investors, whether they’re individuals or institutions, know exactly what they own and why. Fixed income can be a powerful tool for stability and income, but only if expectations match reality.
For advisors, that means taking time to explain how bonds behave and how risks like interest-rate movement, credit quality, and liquidity work. For investors, it means looking past daily price changes to the underlying math of yield-to-maturity and total return.
Related: Declining Rates? This Overlooked Fixed-Income Asset Could Outperform Everything Else