Workplace pension – bonds crash confusion

[KettleOn919]

I know we have had questions about this before, but can someone have one last go at explaining the bonds/gilts situation to me please? I am utterly dense with anything to do with money.

At only three years until retirement, I'm in a workplace pension that has continued to chuck loads of my contributions into long bonds despite the ongoing crash. This has turned out to be particularly painful for me because 18 months ago I added AVCs and since then have been loading my entire salary into this pension while I live on my dwindling savings. Well, it seemed like a good idea at the time!

It's been a disaster. Before this my pension was tiny (I started late in life and don't earn much) but after 18 months of this it's now even tinier. £13,000 less than I've paid in over my working life, in fact. It's losing my entire monthly contribution, plus a bit more, every month.

Someone on the Moneysavingexpert forums has asked whether bond losses will recover as equities are likely to, or whether the losses are "baked in". I am afraid I don't understand the answers, no matter how many times I reread (told you I was dense). But their question was the same as mine. Can anyone explain in simple terms? I want to stop doing what I'm doing if I'm doing something stupid!

Many thanks.

Bonds lose value when interest rates go up. If you hold a bond paying 3% and a new bond of the same quality is now paying 5%, your bond goes down to a value that would give a 5% return. The effect is worse with long-term bonds because the interest difference lasts longer.

Bonds go up in value when interest rates fall. If you have a bond paying 5% and the ones on the market pay 3%, the market value of your bond will rise until it also yields 3%.

This is all assuming your bonds are being sold before maturity. If you hold the bond until it matures, you will get all of the interest payments and the face value at the end.

I don't like long-duration bonds for this reason. I will only invest in bonds with a duration of 5 years or less. I get a bit less interest, but less risk also.

I understand that this is a bit counterintuitive. This may explain it better than I have. I'm happy to answer questions if you have them after reading this.

www.investopedia.com/ask/answers/why-interest-rates-have-inverse-relationship-bond-prices/

No losses (or gains) are ever baked in until you sell.

The reason people are advised to increase their proportion of retirement savings invested in bonds as they approach retirement is because fluctuations in bond prices tend to be smaller than fluctuations in share prices.

The thing to remember is that you have exactly the same number of bonds as you bought. (More likely to be units in a fund that invests in bonds ... but basically the same thing). If you sold those units/bonds today, then yes, you'd probably get back less money than you may have paid for them (for the reasons explained by the PP), because in the interval since buying them, interest rates have risen.

What you need to ask yourself is a) why would you sell them today? and b) what might they be worth when you eventually come to sell them?

If you believe things are cyclical, like many people do, the very worst thing you could do is switch from bonds to equities, because the next crank of the handle will see equities drop. At some point interest rates will come down and then bonds will go up again. If you hold, you may even reverse any losses. The question really is, when is that 'some point' and when will you sell?

But, if you believe that interest rates will continue to rise, to 6%, 7%, 8% or more, and stay there beyond when you need your retirement funds, then you'd be better off cutting your losses before that happens. If you did that, then yes, those losses would be baked in.

No easy calls in investment and finance - that's why the ones who are good at it make so much money. The ones who aren't tend to lose their shirts ...

Who is your pension with

It's a workplace pension and it's with Aviva, @HermioneWeasley A mixture of BlackRock Consensus and over 15-year Gilt Tracker. I did change future contributions to have a higher proportion of equities a few months ago, but by then a huge proportion of contributions had already been sunk into 15 year gilts.

@Mark19735 and @MissConductUS I wasn't thinking of crystalizing my losses by selling the bonds I already hold; I was more worried about a) what to do with future contributions and b) whether the gilts I have been buying during the severe crash would always have a value of much less than I have paid for them.

Thanks so much for the info you linked to, I'll read it again later and try to absorb it a bit better.

I wish I had understood all this before I started chucking money at it. As a money dunce I was fooled into thinking that the pension fund managers would rebalance things in response to any unfolding dramatic events in the financial world!

Did you select the 15-year gilt tracker or did the pension plan? If it was your choice, they won't fiddle with it for you.

If you have control over how future contributions are invested, I'd see if you have an option for shorter duration bonds.

@MissConductUS

No, I didn't opt to put 70% of my contributions into the 15-year gilt tracker. That was decided by my pension scheme. I was automatically put into their "Lifecycle" default fund is, where the closer to retirement you get the more of your contribution they put into long gilts.

I did change it a few months ago to put a smaller proportion of my future contributions into bonds, but unfortunately there are very few to choose from and they all seem to be tanking (although not as badly as the bonds!)

The lifecycle funds in the US have undergone similar carnage. There was no place to hide in 2022. All of my contributions in 2022 went into a money market fund option.

Disclaimer - I am not regulated by the FCA to provide pension advice, but I’d move back into a lifecycle default. 3 years from retirement you should be minimising exposure to equities but it is long enough for your bond returns to come back. Please don’t play with your funds and your risk profile if you don’t know what you’re doing.

@HermioneWeasley Thanks, but oh crumbs... this is exactly the kind of thing that my feeble brain cannot understand. How can my bond returns "come back" seeing as how they are gilts and therefore have been bought with fixed interest? I am assuming that every new lot of gilts my contributions have bought during the crash have come with smaller and smaller potential returns, and that these are locked in. So am I not now just stuck with a load of bonds that are always going to be low value?

Sorry if I am still not getting this!

See post 2. The value of a bond or gilt changes inversely with changes in interest rates.

If I gave you an IOU that said "I'll give you £10 worth of tomatoes in a year [topical] ..." how many tomatoes would you get? Last year, you might have expected you'd get 20 tomatoes. Today, you might be happy if you got 5. A bumper Spanish harvest in 2023 and next year you might actually get 30. Who knows? The wording of the IOU doesn't change - it's still for £10 worth of tomatoes, but the actual number of tomatoes it's worth does change.

I am assuming that every new lot of gilts my contributions have bought during the crash have come with smaller and smaller potential returns, and that these are locked in. So am I not now just stuck with a load of bonds that are always going to be low value?

Not quite. You are buying shares in a very large pool of gilts, some of which were bought years ago. And the gilts the fund is buying now pay more interest, so they will go up in value if interest rates fall.

Can you look up the average duration of the bonds in the tracker, and the overall portfolio yield?

Long dated bonds(10 years plus duration) are not a safe investment in a rising rate environment, they come into there own when rates are being cut. Basically the duration of the the bond fund is a guide as to how long it takes to recover.
Bond funds are self healing in that they are constantly buying new bonds as the existing stock mature, so will eventually recover their loses but if the average duration was 10 years that's how long you can expect to get back to par, although you will still be receiving coupons which if reinvested would get you there quicker.
As a bond yields rise, the price falls as the old bonds have to compete with new bonds with higher rates. No one wants to buy a bond that yields 1% when there are new bonds paying 4% so the price has to be discounted to allow for the the lower yield.
Yields have risen alot in the last year hence the dramatic fall in price in long duration bonds, some gilt funds are down over 30%.
In my opinion a 30/70 equity/ bond split is a bit too conservative for someone not yet retired.
Have a look at the asset allocation in vanguard target date retirement funds for comparison.

@MissConductUS It says 96.7% in over 15 years maturity bonds. I don't know how to look up the yield.

@Bucks67 The fund has lost 34.30% in the last year, and 38.08% over the last 3 years. Ouch!

1 option would be to remain as you are and with good fortune inflation will come under control in due course and the BOE will be able to cut bank rate. This would be good news for long bonds as it would make older bonds more attractive again and their price would rise, going some way to repair the damage. However to fully recover you would need rates heading back close to zero, which seems unlikely, so you would still have to wait it out to get back into the black.
If you continue to buy into the gilt fund now most of the damage is hopefully behind us, when rates turn down you benefit more because you are now buying the bonds at a low price and the price will rise as bank rate comes down.
A bit like buying stocks after a big crash you benefit when they recover, think of it like a sale.

Thanks to everyone who has helped me to understand this. I still need to read and reread again, but I'm halfway to getting it now.

@Bucks67 I hope most of the damage really is behind us! Unfortunately the bonds fund suffered another very steep drop in February, so it doesn't seem to be turning a corner yet. Maybe I should switch to 50/50 bonds equities for a while.