TAILIEUCHUNG - Risk of loss: Should investors shift from bonds because of the prospect of rising rates?

Executive summary. Many investors, whether individual or institutional, hold a diversified bond portfolio primarily to mitigate the volatility inherent in stocks or other risky However, with yields presently at or near historic lows, more investors view the bond market as abnormally risky. Indeed, the preponderance of thought is that if and when interest rates rise, the fixed income portion of an investor’s aggregate portfolio may face volatility and loss. Coincidentally, the phrase “bond bubble” is gaining currency. Given many investors’ concerns, we offer some perspective on the prospective risk of higher interest rates to a broadly diversified bond First, we dissect the math of nominal bond returns during. | Vanguard Risk of loss Should investors shift from bonds because of the prospect of rising rates Vanguard research July 2010 Executive summary. Many investors whether individual or institutional hold a diversified bond portfolio primarily to mitigate the volatility inherent in stocks or other risky However with yields presently at or near historic lows more investors view the bond market as abnormally risky. Indeed the preponderance of thought is that if and when interest rates rise the fixed income portion of an investor s aggregate portfolio may face volatility and loss. Coincidentally the phrase bond bubble is gaining currency. Given many investors concerns we offer some perspective on the prospective risk of higher interest rates to a broadly diversified bond First we dissect the math of nominal bond returns during and after a hypothetical rise in interest rates. We then compare this risk with 1 We recognize that investors may also hold bonds for the income they produce as part of a portfolio spending plan. However for this discussion we elected to focus on the diversified total return investor. 2 For this discussion when we refer to bonds we are only concerned with a broadly diversified high-quality bond portfolio. Portfolios focused on corporate bonds including high-yield bonds or laddered portfolios of individual bonds can face additional risks such as credit risk widening spreads and or default for corporate bonds or liquidity and concentration risk for smaller laddered portfolios. For a more detailed discussion on the role of individual bonds versus bond funds see Bennyhoff 2009 and Donaldson 2009 . Authors Christopher B. Philips CFA Francis M. Kinniry Jr. CFA David J. Walker CFA Connect with Vanguard . investors the risks inherent in the stock market. We move on to evaluate the past experiences of investors in . bonds in different interest rate scenarios. Finally we take a global perspective .

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