What happens to bond funds if inflation rises?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
Topic Author
flybird145
Posts: 22
Joined: Thu Dec 19, 2019 6:09 pm

What happens to bond funds if inflation rises?

Post by flybird145 » Fri Jul 31, 2020 10:08 pm

Hi all,

I had a question -- suppose you own a short-term bond fund and inflation picks up... What happens to your investment over the long term?

I understand that if you own an individual bond or CD you end up losing money, especially if inflation exceeds your rate of return. But I'd imagine the bond fund is kind of like a CD ladder...so the CDs that mature get picked up at higher rates thus helping protect against inflation. Is that right? Overall though, do you still lose money?

dbr
Posts: 33185
Joined: Sun Mar 04, 2007 9:50 am

Re: What happens to bond funds if inflation rises?

Post by dbr » Sat Aug 01, 2020 7:52 am

If inflation rises and real interest rates stay the same, then nominal interest rates will increase. If real interest rates also rise then nominal rates will rise even more. When nominal rates go up the value of your bond fund will go down and then rise again as increased yields eventually overcome the loss of value. All of this is explained under the concept of duration interpreted as the time to indifference against a change in interest rates:

https://www.bogleheads.org/wiki/Bonds:_ ... s#Duration

A different question is to determine what is the real interest rate on your investments. The real rate can be negative and when it is you investment will constantly lose value to inflation. (This is not to be confused with the possibility that even nominal rates could become negative, but that has not yet happened in the United States.) Right now most nominal bond real rates are negative as yields do not keep up with inflation. Real rates in things like TIPS are negative right now. Real rates on I bonds are not negative but pretty much zero. If inflation increases real rates could stay negative or could turn positive, but that is not closely correlated with inflation.

You can certainly lose money in a bond fund or in bonds sold before maturity both in actual dollars and certainly in real dollars even if you do hold to maturity.

Robot Monster
Posts: 765
Joined: Sun May 05, 2019 11:23 am
Location: New York

Re: What happens to bond funds if inflation rises?

Post by Robot Monster » Sat Aug 01, 2020 9:03 am

flybird145 wrote:
Fri Jul 31, 2020 10:08 pm
Hi all,

I had a question -- suppose you own a short-term bond fund and inflation picks up... What happens to your investment over the long term?

I understand that if you own an individual bond or CD you end up losing money, especially if inflation exceeds your rate of return. But I'd imagine the bond fund is kind of like a CD ladder...so the CDs that mature get picked up at higher rates thus helping protect against inflation. Is that right? Overall though, do you still lose money?
You mention "inflation picks up" and then further down you mention "higher rates" (bolded above). If we get higher inflation that will not necessarily translate into higher rates because the Fed is purposely suppressing rates in order to stimulate the economy.

If you own a bond fund--let's say $10,000 worth of shares--and inflation picks up and yields don't change, simply means your $10,000 will be able to buy less next year.
Investors often exhibit a tendency to evaluate the performance of their portfolio over very short horizons (e.g. days) even when their actual investment time horizon is quite long (e.g. decades).

Post Reply