"Rising interest rates = buying bonds" is suicide. The cruel seesaw rule
He is an FP1級 (Financial Planner 1st class) who manages assets of 150 million yen. As the Bank of Japan’s rate hike expectations rise, some investors simply react to the news like this. “Interest rates are going up! Then if I buy bonds, the yields will increase and I’ll make money.”
If you’re thinking that, buy a textbook on investing again right now and reread from the first page. That intuition is the exact opposite. In bond investing, “rising interest rates” means the prices of the bonds you hold will crash.
This time I’ll explain the brutal see-saw mechanism between interest rates and bond prices, which can burn you if you jump into the bond market with shallow knowledge.
The Trap of Intuition. “Interest rate” and “price” Are Inversely Related
To put it bluntly: when rates rise, bond prices fall. Conversely, when rates fall, bond prices rise.
Trying to act on the assumption that “rates will rise, so I’ll buy bond ETFs” without understanding this see-saw relationship is like eagerly grabbing an asset that is about to fall. Why does this phenomenon occur? I’ll explain from the perspective of the “appeal of the product” so even an elementary school student can understand.
Who Would Buy “1% Trash”
Imagine you own a bond with a face value of 100 yen and a coupon of 1% per year (old issue). (A new bond with a coupon of 3% per year is issued in the market.
Put yourself in the investors’ shoes. Which would you prefer, “your 1% bond” that pays only 1%, or a new bond that pays 3%? Needless to say, everyone will choose the new 3% product. Your 1% bond would be treated as junk and ignored.
So how can you sell that “1% junk” in the market? There’s only one answer: you have to do a bargain sale (price discount).
“The yield is low, but we will lower the price accordingly.” With that, the bond price (principal portion) is forced to crash until the actual yield matches the 3% of the new product.
Don’t Jump into ETFs with Half-Baked Knowledge
This is the mechanism behind bond prices falling in a rate-hiking cycle. Not only bonds themselves, but also bond funds and ETFs that hold bonds behave similarly.
If you hear news that “rates are rising” and you jump into bond ETFs hoping for higher yields, the NAV of the ETF you hold will fall, and your principal will be eroded beyond the interest you receive. This is a typical losing pattern.
Conclusion
Bond investing is more mathematical and logical than stock investing. The correct approach is to “set in after rates have risen (prices have fallen) to prepare,” and jumping in during the rising phase carries high risk.
A naive person who doesn’t understand the mechanism is fodder for institutional investors. Imprint the cruel see-saw principle in your brain and prepare for market fluctuations.
