Long-Term Bond Funds
The fact that bond principal declines as rates rise poses a big problem for long-term bond fund investors in the near future. As we get ever closer to the dreaded “taper” from the Federal Reserve and the prospect of higher interest rates, long-term bond funds could seriously suffer despite the perception of these investments as “safe.”
The problem is that the vast majority of bond funds do not hold their investments to maturity and thus face losses in principal as a result. Consider that from May to early July, when rates on the 10-year T-Note rose about 1%, the iShares 20+ Year Treasury Bond ETF (TLT) lost about 15%. That’s because 95% of the holdings are more than 25 years in duration, and the longer the duration, the more susceptible bonds are to interest-rate increases.
Now that rates have rolled back a bit from their September highs, the risk has returned to investors that a jump in interest rates — either because of central bank action or simply because of Wall Street sentiment — could significantly damage bond funds.