Do you still profit when bonds fall?

princeofpounds

Ah, the old hold-to maturity myth rears its head.

Holding individual bonds to maturity is no more beneficial from a total return point of view than holding a fund of bonds, as long as you are comparing like-with-like in terms of the underlying assets.

In brief, the reason is that although holding a bond to maturity means you do not make a capital loss, you lose the opportunity to reinvest at the higher yield the lower capital values represent. That is just as real a loss, you just reailse it in terms of lower income rather than lower price.

http://www.morningstar.co.uk/uk/news/109457/myth-busters-bond-market-edition.aspx

http://www.northerntrust.com/documents/commentary/investment-commentary/maturity-bond-funds-vs-individual-bonds.pdf

http://www.vanguard.com/pdf/s354.pdf

It does however mean a more predictable cashflow pattern, which for some people might matter. It comes at a significant cost in terms of lack of diversification however, which is probably ok for 'risk-free' assets like gilts but more serious for corporate bonds with real default risk.

As for the original trustnet article, all it is basically saying is:

- bonds are not priced based on just today's interest rate.
- they are priced on future expectations of interest rates throughout the life of the bond.
- therefore the current price of the bond can and does account for expected rises in interest rates in the future.
- if rates do go up and the bond dips in value, this can be compensated for, to a greater or lesser degree, by the fact that you can reinvest the income from the bond at the higher yields.

I think it's a pretty bad article in terms of style and explanation to be honest.

That's because it's rather facile. It implies you shouldn't worry about rising interest rates because other people worry about rising interest rates and so those worries are priced into bonds already.

Yes, they are. But people are not really worried about rising interest rates. They are worried about interest rates rising more than current expectations. That would put a very different gloss on the mathematics.