Sunday, August 10, 2014

Visualizing Portfolio Losses When Bond Yields Rise

After starting the year at 3%, the 10 year treasury yield made it all the way down to 2.35% on Friday afternoon. It then made a quick burst up to 2.42% where it ended the week.

After a major decline, what would rising treasury yields have on portfolios?

The following chart provides a great visual on the principal losses buyers would incur if they purchased bonds and interest rates were to rise just 1%.



For example; the 30 year U.S. treasury bond ended the week at 3.23%. You entered the market on Friday and purchased $100,000 in 30 year bonds.

If rates were to rise by 1% (bonds were being sold in the open market at 4.23% instead of 3.23%), then your bonds would now be worth $83,500 (a loss of 16.5%).

After a 33 year fall in bond prices, those loading up on bond funds in their 401ks and investment portfolios have completely forgotten there can be massive losses of principal if bond yields begin rising. The Fed hopes that bond prices rise in a slow and steady manor as the economy recovers, but what if bond prices began to rise without a full recovery in place? The is perhaps the black swan event that no one has priced into risk models, and just like the black swan collapse in home prices during the last decade, it is the most likely scenario to occur. 

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