When it comes to investing, one of the key principles to remember is to always follow the price action of the asset you are considering. This holds true for any type of investment, including bonds. In this article, we will explore the risks and realities of bond investments, using the example of TLT, a popular treasury bond ETF in the US markets.
Understanding the Inverse Correlation of Bond Yields and Prices
Before delving into the specific case of TLT, it is crucial to understand the inverse correlation between bond yields and prices. When bond yields rise, as is currently happening globally with the US leading the way, bond prices fall. This phenomenon is a fundamental characteristic of bond markets.
The Irony of Bond Investments around COVID crash period
Let’s take a look at the chart of TLT and examine the time period from March 2020 to the present. We can clearly see that in March 2020, which marked the bottom of the COVID-19 pandemic, bond prices were at their highest. This begs the question: why did bond investments, such as TLT, perform poorly during this time when investors sought safety?
Many individuals, especially those who relied on the advice of their personal financial advisors, were convinced that bonds were a safe haven during times of market turbulence.
Let us assume someone invested a significant portion of their wealth in a bond like TLT, at a price of say $160 in the first week of April 2020.
Fast forward just over three years, and we see that TLT is now trading at $85, having halved in value. This unexpected decline in bond prices has caused substantial losses for investors who bet on the safety of bonds and moved their money out of equities. In comparison, the S&P 500 index has gained nearly 80% since April 2020.
Investors who sold a significant portion of their equities and purchased bonds in April 2020 or even during the market recovery in August 2020 have witnessed devastating effects on their portfolios. This example highlights the importance of not blindly following narratives or advice without considering the price action of the asset itself.
The Danger of Falling for Common Narratives
Too often, individuals fall prey to common narratives and rely on the advice of others without conducting their own analysis. Currently, there may be discussions about stocks only going down from their current levels. However, should we base our investment decisions solely on these narratives?
The key is to allow the asset’s price action to guide our decisions. If an asset’s price is declining, it may be a sign to exit the position. Similarly, if an asset’s allocation in our portfolio is decreasing, it might not be wise to invest more in that asset. Following the price action and making informed decisions is crucial in avoiding potential losses.
The significant decline in bond prices, as illustrated by the example of TLT, will undoubtedly have long-term repercussions. This is not a temporary phenomenon that can be wished away within a short period. Investors need to recognize the risks associated with bond investments and carefully consider the potential consequences for their portfolios.
The bond market, like any other financial market, is subject to market dynamics that can lead to price fluctuations. It is important to be aware of these risks and adopt a cautious approach when investing in bonds. Diversification and thorough research are key elements in mitigating potential losses.
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