Many DIY investors are not really comfortable with bonds and how they work. This is unfortunate because bonds are obviously an important component of the portfolio and become more important for most DIY investors as they age.
How Bonds Work
Simply, bond prices and yields move in opposite directions. Because longer maturity bonds tend to have more future payments, their price tends to move around (i.e. is more volatile) more than shorter maturity bonds.
Total return over time includes the change in price plus the interest earned. Total returns for various maturity Treasury issues are shown in the graph (Click Graph to Enlarge)produced by Econompicdata . The bottom solid line is called the "yield curve". The yield curve is a snapshot at a point in time that shows the yields, by maturity, for a given class of bonds. For example, instead of Treasury issues, a yield curve could be drawn for single A corporate bonds. Typically, the curve slopes upward as shown in the graph. This reflects the greater volatility of longer maturity bonds. If the curve slopes downward, it is called an "inverted yield curve" and usually presages an economic downturn.
The interesting part of the graph produced by Econompicdata is the returns by maturity. As a benchmark, the yield on the 10-year maturity U.S. Treasury note dropped from 3.84% to 2.70% for the period shown. This produced a total return in excess of 14% for the 10 year maturity - great offset to a weak stock market environment and definitely helpful for giving investors a good night's sleep. Notice that the longer maturity issues had greater return--that is, the more risk you took in the bond market, the greater the reward.
Kudos to Econompicdata for this chart.
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