Unrealized losses

Drew O’Neil discusses fixed income market conditions and offers insight for bond investors.

Bond math 101: when yields rise, prices fall. Yields across much of the fixed income universe are near their highest levels in the past two decades. This is great news for fixed income investors because they are able to lock in attractive levels of income for extended periods of time. This also means that investors who already own fixed income might be seeing unrealized losses on their monthly statements. Whether or not those losses should concern you depends on the answer to one question: Why did you buy those bonds in the first place?

For most investors, their fixed income allocation is intended to be the ballast of their portfolio. They purchase a bond for the stable and known attributes that come with owning individual bonds: a known maturity date, a known maturity value, a known yield, and known cash flows over the life of the bond. These key characteristics are locked in from the date of purchase*. Yes, the price of your bond will change over the course of time, meaning that your monthly or quarterly statements will likely show gains and/or losses. The most important thing to keep in mind is that these gains or losses are unrealized. They only become realized should you choose to sell the bond prior to maturity. The key benefits of the bond do not change because the price changed.

The defined characteristics of an individual bond create a dynamic that can be easy to overlook, so let’s draw a comparison to something more familiar. Say you purchased a house a year ago for $500,000. Today, you visit a real estate website and see that the estimated value of your home has decreased to $450,000. Does this change any of the benefits that your home is providing for you? No. Your house didn’t lose a bedroom and your commute time didn’t increase by 15 minutes. It still has the same number of beds and baths, the same square footage, and is in the same neighborhood. It is still serving the same purpose that it served a year ago when you made the purchase: it is providing a roof over your family’s head.

This same idea holds true for the bond holdings in your portfolio. If you purchased a bond a year ago, you open up your statement today, and you see a loss of 5%, that doesn’t change a single thing about the benefit that the bond is providing you. It is still providing the same annual cash flow, the same yield, and it will be redeemed on the same date and price*. The same is true if the price of your bond rises and your statement shows that you have gains. Seeing gains on your statement might make you feel warm and fuzzy inside and seeing losses might make you feel morose, but for a buy and hold investor, neither of these scenarios changes anything about the benefit that the bond is providing to you and your portfolio.

*Barring a default or other extraordinary circumstances.

The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.

Investment products are: not deposits, not FDIC/NCUA insured, not insured by any government agency, not bank guaranteed, subject to risk and may lose value.

To learn more about the risks and rewards of investing in fixed income, access the Financial Industry Regulatory Authority’s website at finra.org/investors/learn-to-invest/types-investments/bonds and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) at emma.msrb.org.