The Returns of Short, Intermediate, and Long Term Bonds

Updated on October 21, 2022

Reviewed by

A young trader studies his laptop in a coffee shop. — Photo:

Compassionate Eye Foundation / Steven Errico / Getty Images

One of the tenets of investing is that with greater risk comes greater return, but that is much truer with stocks than it is with bonds. Stocks come with interest rate risk—the ups and downs of an asset or fund in response to changes in rates.

It's key to understand the risk-and-return relationship if you're thinking of investing in bonds. Look at a few examples to get a better handle on how rates, yields, and risk work together over bond-maturity periods.

Key Takeaways

Short, intermediate and long-term bonds are defined by the bond's maturity.
Bond investors seek higher yield when there is high interest rate risk or greater sensitivity to the health of the bond’s issuer, or when there are changes in the economic outlook.
When interest rates go down, bond yields fall and bond prices go up. However, the extent of bond price movement depends the bond's maturity.

What Are Short-Term, Intermediate-Term and Long-Term Bonds?

Short, intermediate and long-term bonds are defined by the bond's maturity. Bonds are essentially loans from investors to bond issuers. Issuers take the money from investors, pay interest and return the principal after the bond matures.

Short-term bonds have maturities of three to four years, while intermediate-term bonds have maturities anywhere between four and 10 years. Bonds with maturities greater than 10 years are long-term bonds.

The Return and Risk Relationship

Understanding bond market risk begins with grasping that there's a different relationship between risk and yield than there is between risk and average or total return.

Risk and yield are related simply because investors demand greater compensation for taking bigger chances. They'll demand a higher yield when there is high interest rate risk or greater sensitivity to the health of the bond’s issuer, or when there are changes in the economic outlook.

Note

Securities issued by stable governments or large corporations tend to have below-average yields, while bonds issued by smaller countries or corporations tend to have above-average yields.

You can't always expect risk and total return to go hand in hand over all time periods. The reason is that bonds are sensitive to changes in interest rates and that sensitivity depends on the bond's maturity.

How A Bond's Maturity Impacts Its Interest Rate Sensitivity

Any change in interest rates can impact a bond's price. When interest rates go up, bond yields rise but pond prices decline. When interest rates go down, bond yields fall and bond prices go up. However, the extent of bond price movement depends the bond's maturity.

Over the long-term, the chances of interest rate fluctuations increase, which means bonds with longer maturities are more at risk of any price chances on that account.

Note

A one percentage point change in interest rates can impact bond prices in the opposite direction to the extent of the bond's duration. For example, a one percentage point increase in a 10-year bond will reduce its price by 10%.

Historical Bond Fund Returns

If we look at the period between 2012 and 2021, there have been multiple cycles of rising and falling interest rates. According to Morningstar analyzed by BlackRock, here's how different types of bonds behaved in varying interest rate environments.

Morningstar's Core Bond Index includes Morningstar US Government Bond, US Corporate Bond and US Mortgage Bond indexes, implying at least some exposure to long-term bonds.

Time Period	Interest Rate Environment	Core Bond Index	Intermediate core bond
7/26/12 - 12/31/13	Rising interest rates	-1.2%	0.3%
1/1/14 - 7/8/16	Falling interest rates	5.0%	4.2%
7/9/16 - 11/8/18	Rising interest rates	-1.1%	-0.4%
11/9/18 - 3/9/20	Falling interest rates	13.5%	11.5%
3/12/20 - 12/31/21	Rising interest rates	-0.1%	0.6%

2022 Bond Fund Returns

Typically, bonds and stocks move in different directions. But the year 2022 was an exception. To combat high inflation, the U.S. Federal Reserve raised rates by 225 percentage points between March and July 2022.That proved to be catastrophic for bond fund returns.

According to Morningstar data, here's how bond funds performed from the start of the year till mid September.

Category	Returns Jan.1 -Sept. 13, 2022
Ultra Short-Term	-0.89%
Short-Term	-4.97%
Intermediate-Term	-12.10%
Long-Term	-22.22%

Keep in mind that past performance numbers for funds and categories can change quickly, making them tricky.

The Bottom Line

Investors won’t be able to gain the same benefits from owning longer-term bonds as they did from 2008 to 2019 if the bull market in bonds ends, and rates continue to move higher for an extended period. (The Fed has promised that it will.)

Note

Don’t assume that an investment in a long-term bond fund is the ticket to performance, just because it has a higher yield.

Assuming similar future performance of bonds and investments based on past performance is never a good idea. Bonds have tended to provide good returns for the last few decades, but they might not always do so.

Frequently Asked Questions (FAQs)

What is the annual rate of return called when you buy the bond on the open market?

Bond traders who operate in the open, secondary market need to understand the difference between a bond's coupon rate and its yield rate. The yield rate is often what traders care the most about, because that's the actual rate of return they will get for the price they pay for that bond. It might not be the rate of return for the original bondholder—that's the coupon rate. When the price of the bond changes due to market forces, the yield rate will also change. The coupon rate doesn't change, because it's always the price of the payment, compared to the original price of the bond.

How do you calculate a bond's rate of return?

To calculate the bond's rate of return, you just need to divide the annual payment by the market value of the bond. The interest payment, which may also be called the "coupon," remains steady as the price of the bond changes due to market forces. Suppose a bond were available for $1,000, paying a total of $50 over the year. In that case, would would divide 50 by 1,000, giving you a rate of return of 0.05 or 5%. If the bond price were to fall to $800, then the rate would change to 6.25% (50 ÷ 800 = 0.0625).

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Sources

The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.

FINRA. "Bonds."
FINRA. "Brush Up on Bonds: Interest Rate Hikes and Duration."
BlackRock. "Prepare for lower bond returns," Page 2.
Morningstar. "Morningstar Core Bond Index."
Board of Governors of Federal Reserve System. "Policy Tools."
Morningstar. "Why 2022 Has Been Such a Terrible Year for Bond Funds."