Average Performance of Bonds Based on Monthly Interest-Rate Changes January 1926–December 2013 30% • 30-day Treasury bills • Intermediate-term government bonds • Long-term government bonds 20 • Long-term corporate bonds • High-yield corporate bonds 10 Average Performance of Bonds Based on Monthly Interest-Rate Changes This analysis examines how four types of bonds and Treasury bills performed in various interest-rate environments. Monthly changes in the interest rate were tracked since January 1926, then ranked based on direction and magnitude. Periods of rising rates were defined as the top 20% of all 1,055 months. Neutral rates were defined as the middle 60%, and falling rates as the bottom 20%. Returns during the different periods are calculated by averaging the monthly returns and annualizing the monthly average. For example, in the rising-interest-rates period, the returns of intermediate-term government bonds in the top 20% of months were averaged and then annualized to get a negative 8.8%. This analysis is only hypothetical and is not intended to follow bonds over long performance periods. Instead, it is based on monthly changes in interest rates to show the impact of large interest-rate changes on bond prices and is not indicative of long-term trends. Bonds tend to perform poorly in rising-interest-rate environments, and the longer the maturity, the lower the performance. The only exception were Treasury bills, with a small return, but the only positive one. Both intermediate- and long-term government bonds displayed negative returns, with long-term government bonds performing the worst. Corporate bonds also had a negative return that was between intermediate- and long-term government returns. High-yield bonds were the least negative, although negative nonetheless. These bonds tend to be less sensitive to interest-rate movements because they tend to have shorter maturities and carry more credit risk than interest-rate risk. In general, high-yield bond prices tend to be more sensitive to factors such as the financial health of the issuer, the general economic outlook, and corporate earnings, than to fluctuations in interest rates. Government bonds and Treasury bills are guaranteed by the full faith and credit of the U.S. government as to the timely payment of principal and interest. U.S. government bonds may be exempt from state taxes and income is taxed as ordinary income in the year received. With government bonds, the investor is a creditor of the government. With corporate bonds, an investor is a creditor of the corporation and the bond is subject to default risk. Corporate bonds are not guaranteed. High-yield corporate bonds exhibit significantly more risk of default than investment-grade corporate bonds. Debt securities have varying levels of sensitivity to changes in interest rates. In general, the price of a debt security tends to fall when interest rates rise and rise when interest rates fall. Securities with longer maturities and mortgage securities can be more sensitive to interest-rate changes. About the Data 30-day Treasury bills—Ibbotson SBBI U.S. 30-Day Treasury Bill Total Return Index. Intermediate-term government bonds—Ibbotson SBBI U.S. Intermediate-Term Government-Bond Total Return Index. Long-term government bonds—Ibbotson SBBI U.S. Long-Term Government-Bond Total Return Index. Long-term corporate bonds—Ibbotson SBBI U.S. Long-Term Corporate-Bond Total Return Index. High-yield corporate bonds—Barclays U.S. High Yield Corporate Bond Index. The interest rate is represented by the 5-year government-bond yield (the Ibbotson SBBI U.S. Intermediate-Term Government-Bond Yield Index). –10 –20 Rising interest rates Neutral interest rates Falling interest rates Full period return Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2014 Morningstar. All Rights Reserved.