There is a Silver Lining to Higher Interest Rates That Bond Investors Are Missing

Could it be that the worst bear market in history might actually benefit fixed-income investors? It may sound absurd, but if we compare our current bond holdings to those of three years ago in terms of their annuity equivalents, it turns out we are in a better position now than we were when interest rates hit all-time lows in late 2020.

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The next time you come across someone lamenting the unprecedented losses in the bond market, remember that it's a sign of excessive pessimism when investors perceive good news as bad.

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The positive aspect of higher interest rates can be linked to their connection with annuity payout rates, as indicated in the chart above. In 2020, when rates were at or near record lows, a 65-year-old male with $100,000 could purchase a "life & 10 years certain" annuity, guaranteeing an income of approximately $450 per month for life. Today, however, that same $100,000 could secure a monthly income of about $620.

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(These rates are provided by the ImmediateAnuities.com website. A "life & 10 years certain" annuity offers guaranteed lifetime income to the annuitant, with payments continuing to the annuitant's heirs for the remaining 10 years if the annuitant passes away within that period.)

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In essence, even though bond investors currently have fewer dollars than they did three years ago, those dollars have greater purchasing power. Depending on the type of bonds they invested in, some investors might even be in a better financial position today.

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For instance, consider an investor who held the Vanguard Total Bond Market Index Fund ETF. This ETF aims to track the performance of a broad, market-weighted bond index. An initial $100,000 investment in this ETF three years ago may have decreased in value to about $84,000 today. Nonetheless, this reduced amount could still secure a guaranteed monthly payment of approximately $525, which is higher than the $450 monthly payment available three years ago.

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This perspective provides a fresh outlook for bond investors who long for a return to the era of low interest rates. While their bond holdings would undoubtedly appreciate in such a scenario, it's quite likely that the annuity payout they could purchase with the increased amount would be lower.

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