Why Do Bonds Show a Loss?

You bought a bond, Treasury, or brokered CD because you wanted a relatively predictable investment. You know how much interest it pays, when it matures, and—assuming the issuer can meet its obligations—how much you expect to receive at maturity.

Then you open your investment statement and see that it is down 3%, 5%, or even 10%.

What happened?

In many cases, nothing has gone wrong with the investment. What you are seeing is simply the difference between what the investment is worth if you sell it today and what you expect to receive if you hold it until maturity.

That distinction is one of the most important things to understand about owning individual fixed income investments.

Your Statement Shows Today’s Market Value

Individual bonds and brokered CDs are generally assigned a market value on your investment statement. This is sometimes referred to as mark-to-market pricing.

In simple terms, it’s showing what you’d receive for selling the investment today – not what you’ll get if you hold onto it until maturity. 

Why Do Bond Prices Go Down?

One of the biggest reasons is changing interest rates.

Imagine you purchase a five-year bond paying 4%. Shortly afterward, interest rates increase and newly issued five-year bonds are paying 5%.

If another investor has a choice between your 4% bond and a new 5% bond, why would they pay you full price for yours?

They probably wouldn’t.

To make your lower-paying bond competitive, its market price of your investment has to fall. Your investment statement may therefore show your $10,000 bond as being worth something less than $10,000.

That doesn’t necessarily mean you have lost that money.

It means that if you wanted to sell the bond today, you might have to accept less than you originally invested.

What Happens If I Don’t Sell?

This is where owning an individual bond can be very different from simply looking at its current market price.

Suppose you purchase a $10,000 bond and intend to hold it until maturity. During that time, its statement value might look something like this:

*Assuming the issuer does not default and subject to the specific terms of the investment.

The $9,300 value matters if you need to sell at that point. But if the issuer continues making its required payments and you hold the bond until maturity, the temporary market decline does not necessarily determine your ultimate return.

As the bond gets closer to maturity, its market value will generally move toward the amount that will be repaid at maturity, assuming there have not been significant changes in the issuer’s creditworthiness.

Brokered CDs Can Show Losses Too

This can be particularly surprising with brokered CDs which are link bank CD’s but are traded on the secondary markets. 

You might purchase a $50,000 brokered CD and later see a value of $49,000 on your brokerage statement. That can seem strange when you think of a CD as an investment designed to protect principal.

The explanation is similar.

A brokered CD can generally be sold in a secondary market before maturity. Because it can be sold, your brokerage firm estimates what someone would currently pay for it.

If interest rates have risen since you purchased the CD, that value could be less than $50,000.

If you sell early, that lower market value matters. If you hold the CD until maturity, however, you generally receive its maturity value according to its terms, subject to applicable FDIC insurance limits and the financial condition of the issuing bank.

This is also why a brokered CD is not quite the same as a traditional bank CD. With a traditional CD, getting out early may involve an early-withdrawal penalty. With a brokered CD, you may instead need to sell it in the secondary market, potentially for more or less than you originally invested.

The Same Principle Applies to Many Fixed Income Investments

Mark-to-market fluctuations can appear with many investments, including:

• U.S. Treasury securities
• Corporate bonds
• Municipal bonds
• Agency bonds
• Brokered CDs
• TIPS
• Bond Mutual Funds and ETFs
• Other individual fixed income securities

The magnitude of the price movement will depend on factors such as how much interest rates have changed, how long the investment has until maturity, its coupon rate, and changes in the credit quality of the issuer.

Generally, the longer the time until maturity, the more sensitive a fixed-rate investment can be to changes in interest rates.

What About Bond Funds?

Bond mutual funds and bond ETFs are a little different.

A traditional bond fund owns many individual bonds. Those underlying bonds are still affected by the same mark-to-market forces. When interest rates rise, the prices of many of the bonds inside the fund may decline, causing the value of the fund itself to fall.

However, there is an important difference: most bond funds do not have a maturity date.

If you own an individual $10,000 Treasury that matures in five years, you know there is a specific date when the Treasury is scheduled to repay its face value. A traditional bond fund, on the other hand, continually owns a portfolio of bonds. As some bonds mature, the fund generally buys others.

That means you generally cannot say, “I’ll just hold my bond fund until maturity and get my original principal back.” There is no single maturity date when the entire fund returns your original investment.

That does not mean bond funds are necessarily worse than individual bonds. In fact, they can offer significant advantages, including diversification, professional management, easier reinvestment, and convenient access to hundreds or thousands of individual securities.

Bond funds can also benefit from higher interest rates over time. As older, lower-yielding bonds mature or are sold, the fund can reinvest the proceeds into newer bonds paying higher yields. That higher income can gradually help offset some of the price decline caused by rising rates.

So, with a bond fund, it can be helpful to think about total return—both the change in price and the income being generated—rather than focusing exclusively on whether the fund’s share price is above or below where you purchased it.

The fund’s duration can also provide a useful indication of how sensitive it may be to changes in interest rates and approximately how long it may take for higher income to help compensate for an interest-rate-driven decline, although actual results will depend on future rate movements and other factors.

When the Market Value Really Matters

The current price becomes particularly important if you may need your money before maturity.

If you buy a ten-year bond but unexpectedly need the money after two years, there is no guarantee that you will be able to sell it for what you originally paid.

This is one reason it can be helpful to match the maturity of your fixed income investments with when you expect to need the money.

For example, if you know you will need $50,000 three years from now, you might purchase fixed income investments designed to mature around that time rather than purchasing a ten-year bond and hoping its market value is favorable when you need to sell.

This approach can help make short-term market prices less important.