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When stocks are down, bonds hold steady or go up. So why are bonds down?

MARY LOUISE KELLY, HOST:

Stocks fell again today on Wall Street. The U.S. market's down about 25% so far this year. Now, usually, when stocks are down, bonds hold steady or go up, but they're down, too. So what is going on? The Indicator's Darian Woods and NPR's Chris Arnold break it down.

DARIAN WOODS, BYLINE: Owning both stocks and bonds is a basic concept of investing. It's like investing 101, right? You got stocks, which tend to make you the most money over a long period of time.

CHRIS ARNOLD, BYLINE: But they're volatile, right? And bonds are usually more like a slow turtle, just chugging along, paying you a fixed, predictable rate of return.

WOODS: I love this turtle image. So with bonds, you're essentially lending to the government or a big company. They're agreeing to pay you back a fixed interest rate - say, 2% a year. And after a set time period, you get your original money back, too. And so the returns aren't flashy and impressive, but the risk is usually pretty low. You get slow, steady progress - like a turtle.

ARNOLD: Yeah. And when stocks crash, bonds usually hold their value or sometimes even go up. Right now, though, not happening.

DEBORAH MCDANIEL: These last couple months have actually been really brutal.

ARNOLD: Deborah McDaniel is 69 years old. She lives in Bremerton, Wash., and she retired two years ago. And she's got a mix of stocks and bonds in her 401(k).

WOODS: And she thought this was the responsible and safe approach for her retirement account. You know, especially as you get into retirement, most advisors say to have a bigger share of your assets in those safe, steady bonds. So Deborah did that in her portfolio, but...

MCDANIEL: It got hammered. I'm down about, I want to say, like, 25% over the last 18 months-ish.

ARNOLD: And that's brought the value of her retirement account down from more than $500,000 to around $400,000. That's about all she has besides Social Security, so she finds herself thinking, you know, if this goes on much longer...

MCDANIEL: Oh, maybe I need to find a job again, at 69.

WOODS: So here's what's happening. Bond prices are tied to interest rates in this kind of upside-down kind of way. So interest rates fall, bond prices rise - vice versa. And in a recession - you know, when the stock market is usually crashing - the Fed will be anxiously cutting interest rates to boost the economy - you know? - to stem that crash. So in this situation, bond prices would tend to go up.

ARNOLD: But now we are not in a normal situation. Stocks are falling because people are worried that the Fed might cause a recession because it cares so much more about something else - inflation. Inflation's at a 40-year high, and so the Fed is relentlessly raising interest rates to hit the brakes on the economy - slow the economy to try to snuff out inflation. And remember that upside-down relationship, right? The interest rates go up. Bond values go down.

So what does this really mean for you, though? OK, remember that bonds are those slow, steady turtles paying you interest. And bonds are also not, like, the most intuitive thing to understand. So to picture this, think of your bonds as actual turtles.

RICK MILLER: OK. And if you want to use that metaphor - right? - then your turtles have numbers on their backs.

ARNOLD: Rick Miller runs a financial planning service outside Boston. And he says, let's say they have twos on their backs 'cause they're paying you 2% a year on your investment, and they just keep doing that guaranteed. Unless the company fails or something, that's how bonds work.

WOODS: But new bonds are always getting issued, and they might pay different interest rates. And so that's what's happening right now. Interest rates have quickly risen for all kinds of new bonds.

ARNOLD: So now, you could buy the same type of bond, but now let's say it could pay 5% - pay you back much more money.

WOODS: So these are faster, better turtles, essentially - like, we are now racing these turtles. So you have your 2% turtle. It's still going as fast as it used to go. But in a competition, you can see the faster turtle's out there. And if you want to sell your 2% turtle, that's a bit of a problem.

ARNOLD: Is it kind of like nobody wants to buy my crappy, slow turtles?

MILLER: Well they can buy those speedy, nifty, new five turtles. So why are they going to want your slow two turtle? And you can say, well, my turtle is still a nice turtle. It's a really cute turtle. But if you want to sell it, you're going to have to give them a discount.

ARNOLD: That right there is why your bond fund has fallen in value. Basically, you have to cut the price to sell it, or nobody wants it because people have better options - bonds that pay more money back.

WOODS: But - and this is really important - your bonds, even though, on paper, the price is lower if you want to sell them, you're still going to get that same 2% of interest based on the original amount you invested.

MILLER: Your turtle is not dying. Your turtle is not even sick, right? It's just a two.

WOODS: But Rick Miller says a big takeaway here for everyday investors is don't panic and sell all your bonds just because the price dropped.

ARNOLD: Yeah, because, he says, somebody like retiree Deborah McDaniel - if she was making $10,000 a year in interest income off of the bonds in her retirement portfolio, if she doesn't sell them...

MILLER: It should still be generating $10,000 a year - that bond fund - that bond portfolio.

ARNOLD: Even if it's gone down in price, it still pays her the same amount of money. That is key to understand in all of this, and it's reassuring to Deborah.

MCDANIEL: It's good to know that my entire portfolio hasn't tanked. So you'd have to look at not just your balance, but at the income part of your quarterly statements.

ARNOLD: The problem for retirees, of course, is that many do have to sell some bonds from their retirement account to pay for expenses - their rent or their mortgage - or if you're selling shares of your 529 plan to pay your kid's college tuition.

WOODS: Right. Many of those have bond investments that are down. So a lower price does hurt them if you have to sell, and there's just no way around that.

ARNOLD: But, you know, we should say that there is another silver lining here, too. For how many years have you heard people complain about, like, money market accounts? There's no money. There's no return. Interest rates on safe Treasury bonds are so low. Well, now that's changing.

WOODS: So new money that you invest now into bonds, at their current prices and interest rates - those bonds are going to be making you, say, twice as much as they would've before, and they will keep doing that for years to come.

ARNOLD: Now, to jump back to our beloved turtle metaphor here, you know, you've got a bond fund with bonds paying, say, 2%. It is kind of a bummer that they're twos - right? - and not those faster, fancy fives.

WOODS: Right, like, it would be great if you could just magically transform them into turtles that paid a higher interest rate.

ARNOLD: And actually, you know, part of the magical mystery of bonds, as I like to call it, is that, over time, that does sort of happen.

MILLER: Those turtles don't live forever.

WOODS: Wait, wait, I thought turtles lived forever. My turtles are going to die?

ARNOLD: Well, I don't want to say that your turtles are going to die, but I mean, kind of.

WOODS: I'm heartbroken.

ARNOLD: Yeah, I can tell you're very - but look, let's just say they retire. They go to Florida. So after a certain number of years - it depends on the bond - the bond matures, and then it pays you back the original amount of money that was invested in it. And then your bond fund uses that money to go replace that bond with a new bond. You buy new turtles.

WOODS: And if interest rates are higher, the new bonds will pay a higher interest rate.

MILLER: Exactly. And it's much better to fill in with fives than it is to fill in with twos.

ARNOLD: So I guess here, too, it's the advice financial advisors tell you all the time in times of big market swings. With the price of stocks or bonds, don't panic and sell stuff. Just stick with your plan.

WOODS: And with bonds even more so 'cause your dependable little turtles are still handing you tiny, little fistfuls of money.

Darian Woods.

ARNOLD: Chris Arnold, NPR News. Transcript provided by NPR, Copyright NPR.

Tags
Darian Woods is a producer for Planet Money. He blends economics, journalism, and an ear for audio to tell stories that explain the global economy. He's reported on why Australia avoided a recession longer than any other country, how Jamaica used music to fight inflation, and where the United States' two percent inflation target came from.
NPR correspondent Chris Arnold is based in Boston. His reports are heard regularly on NPR's award-winning newsmagazines Morning Edition, All Things Considered, and Weekend Edition. He joined NPR in 1996 and was based in San Francisco before moving to Boston in 2001.