The Bright Side to 2022’s Annus Horribilis for Investments

This year has been disastrous for stock and bond investors. But things are not as grim when viewed in a financial planning context that considers how the assets will be used, i.e., the liability or expense side of the household balance sheet. Interest rates have increased a lot, which means the present value of future spending declines. I’ll use an example of someone at retirement age to illustrate the impacts.

Interest rates

Year-to-date through mid-October, the 10-year Treasury yield increased from 1.52% to 3.67%, and the 30-year went from 1.90% to 3.73%. There have been similar increases in real yields – 10-year inflation protected securities (TIPS) have gone from yielding a negative 1.04% to a positive 1.43%, and the 30-year has risen from -0.44% to +1.58%. Real yields have very quickly moved much closer to the long-term average of 2% or a bit more, after being negative or close-to-zero since the great financial crisis.

It’s straightforward math to demonstrate how interest rate increases result in market value losses for bonds and bond funds. For example, if we put the cash flows from a 20-year, 2% bond into a spread sheet, and calculate the present value at 4%, it comes to about 73% of the par value, equivalent to a market value decrease of 27%. By way of illustration, the Vanguard long-term Treasury fund, similar in duration to this 2% bond example, is showing a YTD loss of 30% through mid-October.

There are also indications that stock market losses reflect the increase in interest rates, although the math is not as direct as with bonds. The market value of a stock can be thought of as the present value of the future cash flows from owning the stock (dividends, buybacks, and future sale price). Of course, the timing and amounts of these future flows are much less certain than for bonds, but those flows get discounted more when interest rates increase. U.S. stocks are down about 25% through mid-October, and my assessment is that much of that decline for both bonds and stocks was from the increase in interest rates.