Why Your Bonds Lost Money This Year, and Why That May Be Good News
VOLUME 18 | ISSUE 4
If you own bonds or bond funds, your third-quarter statement may have raised a fair question: why did the "safe" part of the portfolio lose money?
Through early October, the broad U.S. bond market, as measured by the Bloomberg U.S. Aggregate Bond Index, was down almost 3% for the year,1 with much of that decline coming in the second half of September. The Federal Reserve raised interest rates in September for the first time since 2023, and the yield on the 10-year U.S. Treasury climbed above 5% and has since reached its highest level since 2002.2
That's the bad news, and we won't sugarcoat it. But the same numbers tell a second story. In early October, a 10-year Treasury yielded about 5.3%, roughly what S&P 500 companies were expected to earn over the next year per dollar of share price.3 For most of the past 15 years, that wasn't close to being the case. Bonds are real competition for stocks again.
Why Your Bond Funds Fell
Think of bond prices and interest rates as two ends of a seesaw. When rates go up, the prices of existing bonds go down. If you own a bond paying 4% and new bonds pay 5%, no one will pay full price for yours. Its price has to fall until it offers a competitive return.
How much a bond fund drops depends on its duration. Think of duration as a sensitivity dial: the bigger the number, the more the fund’s price moves when interest rates change. A handy rule of thumb is that for every 1 percentage point rates rise, a fund’s price falls about 1% for each year of duration. The broad bond market’s duration is a little under six years,¹ so if interest rates rise by one percentage point — say, from 4% to 5% — its price would fall by about 6%. That’s why short-term bond indexes, with durations of only two to three years, held up much better this year. Long-term Treasury indexes, with durations of 14 to 15 years, lost about 8% through early October, partly because interest payments offset some of the price decline.⁴
A bond fund never matures the way an individual bond does, but it can recover in its own way. As older bonds mature or are sold, the manager replaces them with new ones paying today's higher rates. That extra income has tended to offset the price decline over a period roughly equal to the fund's duration, provided rates level off. If rates keep climbing, the recovery takes longer.
The Good News: More Income
The silver lining of rising rates is more income. As of early October, the broad bond market yielded about 5.6%,1 up from about 4.3% at the start of the year. As a hypothetical illustration, on a $1 million bond allocation, that difference is roughly $13,000 a year in additional income at current index yields, before fund expenses and fees. As explained below, fund distributions catch up gradually.
Historically, a bond portfolio's starting yield has been one of the best guides to its future returns: J.P. Morgan finds it has explained close to 90% of the variation in bond returns over the following five years.5 Today's higher starting yields have historically pointed to higher future returns, but that is not a guarantee, and the relationship has not held in every period.
Higher income also provides a cushion: at today's yields, interest rates would need to rise nearly one percentage point across all maturities over the next year before the broad bond index lost money.1 After fees, that cushion is smaller.
Bond funds' monthly distributions will creep upward too, but gradually, because each fund still holds older bonds with lower coupons. For a better sense of what a fund earns at today's rates, look at its "SEC 30-day yield" on the fund's fact sheet rather than its trailing distribution rate.
Bonds Still Play Defense (With an Asterisk)
Income isn't the only reason to own bonds. Over the last century, bonds posted gains in 21 of the 25 years that U.S. stocks fell, according to J.P. Morgan.5
In 2022, stocks and bonds fell together because the problem was inflation, and the Fed raised rates aggressively to fight it. When inflation is the main threat, bonds tend to struggle alongside stocks. When the threat is a slowing economy, bonds have usually helped, because interest rates tend to fall (meaning the prices of existing bonds tend to go up) as growth weakens.
What Could Go Wrong
However, we would be doing you a disservice if we made only the optimistic case:
Rates could rise further first. No one can call the peak. PIMCO, one of the largest bond managers, began trimming its underweight in long-term Treasuries in late September, only after long-term yields topped 5%, and yields have kept rising since.7
Inflation could prove stubborn. Oil prices remain elevated amid conflict in the Middle East,9 and inflation that refuses to come down is the scenario in which bonds tend to disappoint.
Government borrowing remains heavy. With the national debt now above $40 trillion6 and larger long-term Treasury sales possible down the road, long-term rates may stay volatile.
None of these risks is a reason to abandon bonds. They are a reason to be thoughtful about which bonds you own, and how much.
What This Means for You
First, a bad year is not a broken plan. Bonds are in your portfolio for income, stability, and diversification over full market cycles, not to win every quarter. Disciplined investors rebalance, which can mean adding to bonds when their prices are lower. That is generally the approach we take with the portfolios we manage, though rebalancing can mean adding to bonds before prices fall further and, in taxable accounts, can trigger capital gains taxes.
Second, while we recommend keeping cash for short-term needs, today's cash yields may not last. Money market yields move with the Fed and would likely fall quickly if it cuts rates, while a bond fund's yield adjusts much more slowly.
Third, year-end may offer a planning opportunity. In taxable accounts, a bond fund trading below its purchase price can sometimes be sold to realize a tax loss and replaced with a similar, but not substantially identical, fund so you stay invested. Keep in mind that wash-sale rules apply across all of your accounts, including IRAs and a spouse's accounts. Also, harvesting generally defers taxes rather than eliminating them, because the replacement fund starts with a lower cost basis. Furthermore, the replacement fund may perform differently when compared with the fund it replaced. For those in higher tax brackets, municipal bonds are also worth a closer look after this year's selloff8 given their tax-exempt income, although munis typically pay lower pre-tax yields and carry their own credit, liquidity and tax considerations, including possible state income tax and, for some issues, the alternative minimum tax.
Your third-quarter statement shows this year's decline. What it doesn't show is the higher income bonds now pay, and that income has historically been the main driver of bond returns over time.10 If you'd like a second opinion on how your bonds and cash are positioned, we'd welcome the conversation.
Important Information
This commentary is provided for informational purposes only and is not individualized investment, tax or legal advice. Data and opinions are as of the dates noted and are subject to change without notice. Forward-looking statements are not guarantees, and actual results may differ materially. Past performance does not guarantee future results. Indexes are unmanaged, do not reflect fees or expenses, and cannot be invested in directly. The Bloomberg U.S. Aggregate Bond Index is a broad benchmark of the investment-grade, U.S. dollar-denominated, fixed-rate taxable bond market. Information from third-party sources is believed to be reliable but is not guaranteed. All investing involves risk, including possible loss of principal. Bonds and bond funds are subject to interest rate, credit, inflation and liquidity risks, and their prices generally fall when interest rates rise.
Notes and Sources
Bloomberg U.S. Aggregate Bond Index as of October 2, 2026, per Bloomberg data in the Raymond James Weekly Rate Monitor (Note 8): year-to-date total return of −2.86%, yield to worst of 5.56% and modified duration of 5.87 years. The rate-rise cushion is approximated as yield ÷ duration (5.56 ÷ 5.87 ≈ 0.95 percentage point), assuming a parallel shift in rates and before fees.
Federal Reserve FOMC statement, September 16, 2026 (target range raised 0.25 point to 3.75%–4.00%). 10-year yield from the U.S. Treasury daily par yield curve; it closed at 5.31% on October 5, 2026. Bloomberg reported that the 10-year yield reached a 24-year high (the highest since 2002) in early October 2026.
S&P 500 forward P/E of 18.91x as of September 30, 2026 (forward earnings yield ≈ 1 ÷ 18.91 ≈ 5.3%), per First Trust Portfolios (Note 9); 10-year Treasury yield per Note 2.
Long-term U.S. Treasury index year-to-date total return of −7.72% as of October 2, 2026, per the Raymond James Weekly Rate Monitor (Note 8).
J.P. Morgan Asset Management, Guide to the Markets, 4Q 2026.
U.S. Treasury, Debt to the Penny.
Raymond James Weekly Rate Monitor, 10/5/26 (Bloomberg data for the U.S. Aggregate, long-term Treasury and municipal bond indexes; municipal bond index year-to-date total return of −3.20% as of October 2, 2026).
First Trust Portfolios, “Market Minute – October 2026” (October 5, 2026): S&P 500 forward P/E and WTI crude oil of about $90 per barrel, up from about $57 at the start of 2026. https://www.ftportfolios.com/Commentary/Insights/2026/10/5/market-minute---october-2026
Capital Group, "4 lessons from 50 years of bond investing" (August 10, 2023)
