Bond Investors Shouldn’t Gamble on the Inverted Yield Curve
Reaching for yield during inversions misses the bigger driver of total return, namely the path of interest rates, which is difficult to predict with precision.
Not worth the ride.
Photographer: Hollie Adams/Getty Images
Long-term bonds usually pay a higher yield than shorter-term ones to encourage investors to lend for longer. But sometimes the so-called yield curve inverts, as it has now, and short-term bonds offer the highest yield. When that happens, it’s tempting to move money to short-term bonds, or even cash, to grab that extra yield. Now that the yield on cash is nearly 5%, why bother with long-term bonds offering 3.5%?
The answer is that for most bond investors, particularly those who own bond funds, yield is only one component of total return, the other being changes in bond prices. When bond prices decline, total return will be lower than the yield, a reality investors encountered last year when interest rates surged, sending bond prices lower (interest rates and bond prices move in opposite directions). Inversely, rising bond prices add to yield, all of which is confirmed by the fact that bond funds’ yield and total return almost always differ.