We've covered lots of ground in this thread. If we want to go back to the OP, well that was pretty much answered in the first reply. What we've been exploring since are the nuances, which the first reply mentioned it was ignoring.
Yes, it's good for novice investors to understand that falling bond prices and rising yields are good if one continues to buy bonds and/or reinvest dividends--eventually. That last word is important. We must be patient.
It's also important for novice investors not to think that future returns are likely to be like past returns, which clearly is one misunderstanding some have. Some of the posts here and in other bond threads show that some folks are just looking at historical returns of 5%/year or more, and expecting that going forward. This is not realistic. Don't listen to me and other anonymous posters, listen to the experts at Vanguard.
Here's another Vanguard paper that's worth reading: Vanguard - The challenges ahead for the bond market (Part 1)
Here's a quote from the article from Bill McNabb, Vanguard chairman and CEO:
The one thing we can be fairly confident about is that the next ten years of bond returns aren't going to be what the last ten years have been, when the broad bond market returned about 5% a year. It's almost mathematically impossible because yields currently are so low.
The current yield of a bond is one of the best predictors of its future returns. So, logically, with yields near historical lows, investors should have much more modest expectations for bond returns. I'm not saying to investors that they should abandon a sensible allocation to bonds. I'm just trying to help set realistic expectations.
He goes on to explain what we're all agreeing on here:
And if interest rates rise, we'll see a decline in bond prices, but over the long term, a rising-rate environment is not a bad thing for people who are in it for income. If you're reinvesting part of the dividend, you'll reinvest at a higher rate and that will compound over time.
Since many people are mislead by historical returns, the following quote also is important to understand. After discussing how bonds had a bad year in 1994 after rates spiked, Bob Auwaerter, head of the Vanguard Fixed Income Group said:
But it's also very important to look at these historical examples in context. A big difference between now and, say, 1994 is that yields are much lower than they were then. In the past, yields have helped offset declines in bond prices. But today we don't have that yield cushion. We are in a unique historical situation with bonds. I've worked in investment management since 1978, and I've never experienced yields this low. You have to go back to the 1950s to find yields at this level.
So, although the duration concept still applies, and after a period, after the last rate increase
, equal to duration, we will start earning higher returns than if rates had not risen, we might have to be more patient to recover from losses than in the past.
I also think it's important for folks to understand the words above in bold. For a bond fund with a duration of five years, if rates were to increase tomorrow, you will not end up the same return in five years (as if rates had not increased) if rates increase again next year--you must restart your duration clock after the next rate increase. And that's just fine as long as we're patient. If rates increase for the next five years and then stay flat for the following five years, we will be better off in 11 years than if rates had not risen.
Of course I think (and I don't think you'll hear this from Vanguard) that those of us who are using fixed-income alternatives, such as non-brokered CDs and stable value funds, for a portion of our fixed income allocation are likely to be even better off as we gradually shift from assets that have not lost any value into higher yielding bond funds (or CDs or SV funds). Sorry, I couldn't resist squeezing that in.