Bond funds are losers, especially long-duration

Some METARs would say that any investment that isn’t a stock is a loser. But some of us like bonds for their predictable cash flows.

Brokerages often recommend bond funds rather than a ladder of carefully-selected individual bonds and CDs. That’s a dangerous investment since a bond fund has no maturity and the Net Asset Value of the fund will drop if interest rates rise with loss of principal.

How Not to Invest in the Bond Market

Investors poured billions into long-term U.S. government funds last year. Right on cue, the market tanked—again.

By Jason Zweig, The Wall Street Journal, April 19, 2024

U.S. Treasury securities are often called risk free, but they aren’t—especially if you’re buying funds that fluctuate every day even though their bonds won’t mature for at least two decades…

As individual bonds approach maturity, they become less sensitive to changes in interest rates. That isn’t the case with most bond funds, however; a long-term fund can remain volatile for as long as you own it. Depending on when you need to sell, that can be good or bad.

If you want to lock in almost a 5% yield for the next 20 years or more, you’re probably better off with a long-term Treasury bond you can hold until maturity than with a long-term Treasury bond fund whose interim value will bounce around…

Long-term bond funds are so sensitive to changes in interest rates that even a 0.25-point move by the Fed will change the value of these funds by approximately 4%…So if you don’t own a long-term bond fund, don’t buy one…[end quote]

Currently, the Treasury yield curve is as close to flat as it has been in a long time. The 10 Year Treasury has risen to a yield not seen for 20 years. The real (TIPS) yield is the highest since 2009.

Based on the Fed’s past moves they will likely cut the fed funds rate during the next recession and the long-term yields will probably drop along with them. That’s why I’m extending the duration of my own bond ladder. As the near-term bonds mature their replacements will probably have lower yields. (This happened in 2002, 2010 and 2020.) I want to lock in the higher yields.

The bond market thinks that the 10-Year Breakeven Inflation Rate will be 2.4%. This is the spread between the 10 year TIPS and Treasury. Will it? Given the hugely increasing government deficits, trade protectionism and other inflationary trends? I think that inflation will surprise to the upside which is why I am buying TIPS instead of Treasuries.

My favorite bond at this time (available on the secondary market) is CUSIP Symbol 912810FQ6, UNITED STATES TREAS BDS TIPS 3.37500% 04/15/2032, issue date 10/15/2001

This TIPS is selling at a premium to yield 2.2% plus inflation. It pays a nice coupon to cover the taxes on the interest and “phantom” interest (inflation adjustment of principal). I plan to hold to maturity which will produce a capital loss on my 1099-B. Like any bond its value will fluctuate with prevailing interest rates.



Not quite, TIPS yields were a bit higher in October 2023. We discussed it back then and I bought a few at the time.

I have a sneaking suspicion that since the Fed is getting such accolades for accomplishing a “soft landing”, they will probably attempt to front run a potential recession with rate cuts before the recession. If they can accomplish this, they will go down in history as it is a very difficult task to accomplish. I think that’s why so many still have a rate cut penciled in for July/September.

1 Like

This METaR says that it makes no sense to pay commissions to a fund when you can buy the bonds yourself. What value does the fund manager give you? None that I can think of.

The Captain

True, by a few tenths of a percent. I bought then, too.


Really? This post is lacking in nuance. While long-duration bond funds can be dangerous in a rising interest environment, generally all bond funds will do well in a falling interest rate environment. Just don’t buy them when it is clear that rates are going up. This is a very easily avoidable risk.

That doesn’t make them dangerous any more than calling stock funds “dangerous” simply because they won’t do well when we are on the cusp of a recession.

The fact is that bond funds, especially short duration bond funds, are an outstanding option right now

Yet that same bond will also lose value if interest rates go up - the value will also bounce around. So, how is it less dangerous than a fund that holds many treasury bonds?

And your favorite bond has lost 3% in value year to date and 7.4% in the last year.

Not seeing how that makes it less “dangerous.” If you go back to 2020, this bond had a cost of over $150. It is currently trading at $108. Seems pretty dangerous if one is buying at the wrong time - just like any other bond fund.

1 Like

The day-to-day value of a Treasury bond doesn’t matter if the bond is held to maturity since it will pay the par value regardless of prevailing interest rates. I construct a bond ladder extending over years and hold all bonds to maturity. I don’t anticipate needing to sell any bonds since the income from my Social Security, bond interest and the principal from the continual periodic maturation of the bonds is more than adequate for my needs. The daily value of the bonds is unimportant since I know exactly what their interest and maturity value will be.

The advantage of a bond fund is the ease of buying and selling shares as opposed to the effort of selecting bonds for a ladder. The disadvantage is that the bond fund doesn’t have a maturity date. The NAV (Net Asset Value) of each share fluctuates with interest rates. It’s impossible to predict future interest rates and principal can be lost when shares are redeemed.


@Hawkwin I can explain with an example.

There’s a bond fund, 10 people buy it and intend to hold for 30 years, the fund collects $100,000 and buys 30-year bonds. Each person puts in $10,000. After 2 years, interest rates shoot up (let’s say something like 1980/1/2) and the fund value drops like a rock to $40,000. Two of the investors panic and sell at that price. The fund has to sell 20% of their bonds for $8000 and sends the money to those two investors. Now the fund had $32000 and 8 investors. After a few weeks/months/years, two new investors decide to buy the fund, and each put in $4000, and each owns 10% of the fund. The fund used the $8000 to by new 30-year bonds. Now 28 years go by and interest rates have dropped again, and the fund is worth $98,000. The 8 original owners that didn’t panic now sell, because they planned on 30 years for their purposes, and they each get $9,800. The remaining 2 stay in the fund because they were planning on 30 years for their purposes.

You can see that the 8 original investors end up with a loss. Had they bought the 30-year bonds directly, they would have been redeemed at 100 cents and they would have received $10,000 as planned, but because two other investors panicked, they only received $9,800.

Now the numbers obviously will be much different, but because a bond fund has to constantly sell and buy based on the flow of money into or out of the fund, gains and losses will be incurred for everyone regardless of when they entered the fund. The effect is not huge, but it is large enough that a bond investor that intends on holding to maturity should be at least somewhat concerned about it.


When Federal reserve is raising rates, that is easy to see. When markets raise rates that is very difficult to predict. US is having dangerous levels of debt, and deficit. Many folks are warning, but I guess both parties will continue to spend, until market punishes them with very high rates. When is difficult to know. Is that something you can predict?

If you cannot, saying don’t buy when rates are going up is easy to say and very difficult to implement.

1 Like

Thanks but I don’t need a summary of how a bond fund works. :slight_smile:

And your example is argumentum ad absurdum. 10 people don’t own a bond fund. Two people selling won’t cause the price to move.

My original post stands. There is nothing inherently “dangerous” about a bond fund unless you are completely ignorant of how interest rates and inflation can impact a bond fund - and that same risk can apply to individual bonds even if you plan to hold them to maturity; life can happen causing you to need to sell at a loss. If you buy at a premium, individual or in a bond fund, you will eventually have a loss of principal or NAV.

Rates going up a fraction of a point, or even a whole point is not the risk (and I would agree not something one could historically predict). Rates going from zero to 5% is the risk - and it is and was easily avoidable and predictable.

Let’s make a bet. I bet the 2 yr Treas will be 5.5% or less a year from now. I feel very confident in that bet - enough to put my personal money on it. I imagine you would make the same bet. I also bet rates, short or long, are not headed to 10% in the near future. Seems like a safe bet to me. Would you agree?

I would also have bet that it was going to be higher, much higher than the 0.75% it was in early 2022. Enough so that I advised people to stay away from bond funds, especially long duration funds. No shocker that it was the worst year on record for the bond market - individual or bond funds.

1 Like

We are coming exceptionally low interest rates, which are anomaly. When a rate even if it goes up by 1%, from 5% to 6%, basically you are looking at 20% rate hike and depending on maturity you are looking at easily 15% to 20% bond price decline. When you have a $1 M portfolio that is suddenly $200K hit.

I don’t believe in these bets; I make much meaningful bets in the market with real money.

1 Like

But you can never hold a bond fund to maturity. It always has market risk. Holding individual bonds can also have market risk, but only if not held to maturity. When you buy an individual bond, you know exactly what return you are going to get (except for default risk, of course). When you buy a bond fund, you don’t know what return you are going to get. You might have a guess - even a very well educated guess - but you don’t have any certainty.



I would agree that the yield of the 10 year Treasury will probably not go to 10% in the “near future” (whatever that means) because the real yield probably won’t go above 2.5% (the historic average) and the inflation rate probably won’t go above 7.5%.

However, the inflation rate actually DID go to 9% for a time in 2022. So it’s not completely out of the realm of possibility.

And the yield of the 10YT doesn’t have to go to 10% to devastate a bond fund’s NAV. It only has to rise significantly higher than 4.6% – not impossible since it hit 5% in October 2023. Is it absurd to predict, say, a 6% yield from the 10 YT if inflation stays at 3% and the bond market’s real yield spread increases from 2.5% to 3%?

Should a conservative bond investor be willing to risk their portfolio on a bond fund by assuming that inflation won’t rise over the 10 year life of the bond…given the immense deficits the government is predicted to run over that time frame?

Maybe not such a safe bet, @Hawkwin?



I guess it depends on your definition of risk. If you held a low paying bond of moderate duration and inflation suddenly spiked to 9% (as it did), then even though you got your money back, it was worth less than when you started - even including your coupon. Of course that kind of fluctuation will hammer a bond fund as well. Meanwhile the S&P has returned an annualized 25% since the pandemic started. You pays yer money and you takes yer chances.

Well OK, but isn’t there another side to the coin? It can’t be all one way; if interest rates drop, shouldn’t a bond fund prosper?


Quite true; it is just that many individual bond investors hate/fear volatility.


Many (most?) people use bonds to stabilize their total portfolio. And many of those use bonds to provide a known amount at some time in the future. For example, if someone knows they need $12,000 (in addition to regular pension and regular social security and regular dividend payments) in 2025, and $10,000 in 2026, and $11,000 in 2027, and $14,000 in 2028, etc then they could quite easily form a bond ladder with those amounts maturing in those years as desired. Then they know exactly when the money is coming and exactly how much is coming (assume treasuries for this exercise). Now what is their alternative with regards to using a bond fund? If they buy a medium duration bond fund, come 2025/6/7/8/etc, they are at the whim of the bond market at that time and may have to sell more bonds to realize the amount of money they require, and then they will have less remaining for the future. It is indeed true, that there is a possibility of gaining as well. Let’s say they put $100,000 into the bond fund, and interest rates suddenly start dropping, then their fund will gain in value, and when they withdraw some each year, they will have more remaining for the future. But remember, the bond portion of their portfolio is more for certainty of that particular money being available when they need it, not so much as an instrument of investing for a possible higher return. That’s what the other parts of their total portfolio is for.


Of course…but at the same time, each individual bond in a portfolio also is worth more. I bought 10 year TIPS in October 2008 when their YTM was 3%. When interest rates fell their value rose so much that I was tempted to sell them. But I held to maturity because no other bonds at the time could match their yield.


Wouldn’t every comparable bond roughly match their yield? If you had $100k face yielding 3% over inflation, or $3,000 + CPI, then if they were worth $150k at that point, and you sold them, and then you bought new TIPS yielding 2% over inflation, wouldn’t $150k of the new TIPS also yield $3,000 + CPI?

1 Like

Interesting point. Actually the market is predicting one year inflation at 4.55% and if you add real rates, the rate should be 7%. Either the inflation expectations are wrong, or the current interest rates are low!

How exactly it is going to resolve needs to be seen; I am already moving away from inflation will drop/ stay below 3% and FED will cut rates to rates may stay where they are, it may not go up but not coming down in any hurry. Suddenly 6% yield is not feeling so great :frowning: For now, I have parked significant cash in treasury bills and trying to stay nimble.

1 Like

@Kingran where do you get that number?



That is one year forward inflation plotted using Overnight index swap, which is a better measure. This is available in Bloomberg terminal if you have subscription.

This study examines the forecasting performance of inflation swaps and survey-based expectations for one-year inflation. Conducting this exercise helps determine if one set of expectations can provide a cleaner signal about future inflation. The study finds that, overall, inflation swaps more frequently provide better forecasts of future inflation.