The Meaning of Holding Bonds Now That Interest Rates Are Rising

For a long time, it was taken for granted in Japan that there was almost no interest.

Money in savings accounts barely grew.
Even if you bought government bonds, the interest earned was minimal.

If you wanted to grow your assets, you had to look toward assets with price fluctuations, such as stocks.

However, that premise is now beginning to change.

The Bank of Japan has raised its policy interest rate, and government bond yields in the United States are also at high levels.

With this, it becomes meaningful to look at bonds, even for those who have not paid much attention to them until now.

You can hold assets while receiving interest without aiming for the large price gains of stocks.

With the return of interest rates, such options have become more realistic than before.

[Bonds are meaningful precisely because they are ‘plain’]

When it comes to bonds,

they are plain with little price movement.
they don’t make as much profit as stocks.
the mechanisms are a bit hard to understand.

I think many people have that impression.

When I was prioritizing asset growth myself, I inevitably found myself looking toward stocks.

Even if I prioritized safety, if the interest earned was too low, it was hard to feel the point of going out of my way to hold bonds.

However, when interest rates rise, the situation changes.

Savings accounts earn interest.
Government bonds offer higher yields than before.
There are more options for corporate bonds.

We are moving away from an environment where stocks are the only option if you want to grow your money significantly, as was the case before.

In other words, it is no longer necessary to subject all of your money to the same risks.

[Cash, bonds, and stocks have different roles to begin with]

This is a point I would like to organize and think about.

Cash provides a great sense of security.

It can be used immediately when needed.
Its price does not fluctuate significantly.

When preparing for living expenses or sudden expenditures, cash has strengths that other assets do not.

However, cash has a weakness called inflation.

Even if the figure of 1 million yen does not change, if prices rise, the amount of goods you can buy with that 1 million yen decreases.

So, are bonds resistant to inflation?

Not necessarily.

Fixed-income bonds, in particular, have predetermined interest payments.

For example, even if you receive 3% annual interest, if prices rise by 4% per year, your real purchasing power will decline even if the face value increases.

In that sense, fixed-income bonds also have a weakness against inflation, just like cash.

On the other hand, stocks have a slightly different nature.

If a company can pass on price increases to its selling prices and grow its sales and profits, that growth may be reflected in its stock price and dividends.

Of course, this does not mean that stocks will always beat inflation.

Nevertheless, over a long time horizon, they can be considered an asset that expects to overcome price increases through corporate growth.

Therefore, I think it is easier to think about them by dividing their roles as follows:

Cash is an asset for use in the near future.
Bonds are an asset for steadily preparing money to be used in the future.
Stocks are an asset for expecting long-term growth and resistance to inflation.

I believe this way of thinking is easier to understand.

It is not a matter of one being superior to the others.

Each has different strengths.

[Bonds are used not to beat inflation, but to buy time]

Understanding this will change how you view bonds a little.

Bonds are not necessarily assets for beating inflation.

Rather,

receiving interest over the time until you know when and how much you will spend.

It makes more sense to think of them as assets for that purpose.

For example, suppose you need 5 million yen for home repairs in five years.

If you keep that 5 million yen in stocks, there is a possibility it could grow significantly.

However, there is also a possibility that stock prices could fall sharply in five years.

Conversely, if you hold bonds that align with that five-year timeframe, it becomes easier to prepare the funds while receiving interest.

Of course, there are credit risks for the issuer, but

preserving funds in a form that can be used when needed, rather than growing them.

This is where the meaning of bonds lies.

[When yields return, the need to force yourself to hold stocks diminishes]

Previously, the yields obtainable from highly safe bonds were extremely low.

In that case,

if this is all the interest I can get, I might as well invest in stocks.

It is no wonder that some people thought this way.

However, when you can obtain a certain level of yield from highly safe bonds, the situation changes.

You do not necessarily need to aim for large capital gains with all of your money.

Money for growth.
Money for protection.
Money to be used in a few years.

You can give each one a different role.

This is not just a topic for those in their 60s.

For young people as well, when your assets grow in the future,

there is no need to keep everything in stocks.

Knowing this option is meaningful.

When you are young, keep your stock ratio high.

Increase your bond holdings according to your age, asset size, and planned usage.

If you know this way of thinking from an early stage, I believe the range of your future asset planning will expand.

[However, rising interest rates are a headwind for existing bonds]

This point is extremely important for understanding bonds.

Rising interest rates are attractive for those buying new bonds.

However, the price of bonds that have already been issued may fall.

For example, suppose you hold a bond with a 2% annual interest rate, and a new bond with a 4% annual interest rate is issued.

Under the same conditions, most people will choose the 4% one.

As a result, the old bond with only 2% interest will not be attractive unless its price is lowered.

In other words,

rising interest rates are a tailwind for new buyers.
They can be a headwind for those who sell midway.

Bonds have these two faces.

This is the reason why you cannot simply say you should buy them just because the yield is high.

Furthermore, for individual investors in Japan, there is also the option of ‘Japanese Government Bonds for Individuals’.

In particular, the 10-year floating-rate bond has an applicable interest rate that is reviewed to reflect market interest rate movements, and a mechanism for mid-term redemption is provided after a certain period has passed since issuance.

The characteristic of Japanese government bonds for individuals is that they are the strongest means of avoiding the ‘price decline risk’ during periods of rising interest rates.

[Think about bonds in terms of ‘when you will use the money’]

When I think about bonds, I believe that what is just as important as the yield is,

when you plan to use that money.

That is what I think.

If you buy a 10-year bond with money you plan to use in 5 years, there is a possibility that you will have to sell it midway.

If interest rates have risen further by that time, the bond price may have fallen.

On the other hand, if you buy a 10-year bond with funds you do not plan to use for 10 years and can hold it until maturity, you do not need to worry so much about price fluctuations along the way.

As I have written several times in previous articles,

rather than what to buy, it is when you will use that money.

This way of thinking is especially important for bonds.

[You should not look only at the yield for U.S. Treasury bonds]

When the yield on U.S. Treasury bonds becomes high, it looks very attractive if you only look at the numbers.

However, when we who live in Japan buy U.S. Treasury bonds, there is another major factor.

Exchange rates.

Even if you receive high interest in dollars, if the yen appreciates significantly during that time, the value when converted to yen will decrease.

Conversely, if the yen depreciates, you may realize a foreign exchange gain.

For U.S. Treasury bonds, you must consider

interest rates,
bond prices,
and exchange rates.

You need to look at these three things.

Furthermore, if you think long-term, there is also the inflation I mentioned earlier.

Even if you are receiving a high coupon, if the U.S. inflation rate exceeds it, your real purchasing power in dollar terms will decline.

Therefore,

high yield does not necessarily mean advantageous.

It is not that simple.

With bonds, you need to consider not just the nominal yield, but also inflation and exchange rates.

[Bonds are assets that connect money and time]

Bonds have a slightly different appeal than stocks.

If you have money you plan to use in five years, consider a bond with a five-year term.

If you have money you plan to use in ten years, consider the maturity accordingly.

If you can hold it until maturity, you can prepare the funds you will use in the future while receiving interest in the meantime.

Thinking of it that way, bonds are not just safe assets, but perhaps they can also be called

assets that connect money and time.

Don’t you think?

With stocks, you don’t know how much they will be worth in ten years.

Cash can be used at any time.

Bonds sit in between, allowing you to

decide to some extent when to use the money while also putting that time to work for you.

You can give them that kind of role.

[Next, the concept of staggering maturities]

When interest rates rise,

one might be tempted to think,

I should buy long-term bonds in bulk while I can.

However, if interest rates rise further, there is a possibility that you could buy them at an even higher yield.

Conversely, if interest rates fall, it would have been more advantageous to have secured the current yield.

Accurately predicting future interest rates is not easy.

That is where

buying with staggered maturities

comes into play.

For example,

bonds maturing in 1 year,
bonds maturing in 3 years,
bonds maturing in 5 years,
bonds maturing in 10 years.

This is how you diversify over time.

You reinvest the funds that reach maturity according to the interest rate environment at that time.

This is the concept known as a bond ladder.

I will stop here for today, but I believe this method is a very interesting mechanism for those who want to receive interest while protecting their assets.

[Rather than how much you earn, what you hold it for]

During the long era of low interest rates,

deposits don’t grow,
bonds don’t grow,
so I buy stocks.

There was rationality in that way of thinking as well.

However, things are a little different now.

Cash has the role of being immediately available for use.

Bonds have the role of allowing you to prepare for future expenses with a certain degree of predictability.

Stocks have the role of providing expectations for long-term asset growth and resistance to inflation through corporate growth.

I believe it is important not to confuse these roles.

Cash protects your living expenses in the near future.
Bonds steadily prepare the money you will use in the future.
Stocks seek to capture long-term growth and the power to overcome inflation.

Bonds alone may not be enough to sufficiently counter inflation.

Stocks alone might be down in the market when you need the money.

Cash alone may lose its purchasing power over the long term.

Therefore, rather than choosing just one as the correct answer, divide the roles.

With interest rates having risen, it has become easier to divide those roles than before.

I believe that is where the great significance of bonds lies today.

The purpose of holding bonds is not simply to receive interest.

It is to protect the money you will use in the future while also having it work a little during that time.

Allocate the portion that grows over the long term while overcoming inflation to stocks.
Allocate the portion that is steadily prepared with an eye on when it will be used to bonds.

Thinking of it this way, bonds are not a substitute for stocks, but rather an asset that does a different job than stocks.