The reversal of decades of interest rate declines has revealed an ugly side to owning bonds, but let’s not get too caught up in appearances.

Bonds are still the Number One way to protect portfolios from sharp stock market declines. You can see this in recent one-month comparative returns for stocks and bonds. Globeinvestor data shows that the FTSE Canada Universe Bond Index was up 0.2 per cent while the S&P/TSX composite index fell 2.7 per cent, the S&P 500 fell 7.4 per cent and Nasdaq fell 12.1 per cent.

Let’s not kid ourselves about bonds – they have fallen hard in price this year. Interest rates are rising to subdue inflation, a development that is negative for bonds. Over the past 12 months, bonds have fallen more than the S&P/TSX composite and S&P 500 indexes. No wonder I keep hearing from readers asking if they should sell their bonds and buy guaranteed investment certificates.

Bonds have calmed down in late May, though. Prices rebounded mildly and yields eased off the highs seen earlier in the month (yields and prices move in opposite directions). Investors are digesting the idea that rising rates will slow the economy down and possibly lead to recession. If that’s the case, then the bulk of the damage to bonds from higher rates may already be behind us.

A less negative outlook for bonds may be helping them perform their critical mission of providing returns that are not correlated to stocks. If nothing else, bonds are reminding investors that current market conditions we’ve seen in the past year are an anomaly. Over decades of investing, bonds will provide an effective hedge against stock market declines.

Something else bonds are doing today is providing more interest income. The after-fee yield to maturity on bond ETFs tracking the FTSE Canada Universe Bond Index is about 3.3 per cent these days, compared to about 1.4 per cent in early 2021. Investment-grade corporate bonds maturing in five years or less offered yields in the low 4 per cent range in late May.

Investors who buy bonds today can lock in these yields and, if they’re patient, they might see some price gains as well in the months and years to come. Also, they get some protection against stock market declines. In the long term, that’s the top reason to own bonds.

Also see: Peak interest rates may be lower than expected as growth slowdown looms

— Rob Carrick, personal finance columnist

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