As any bond owner knows, 2022 was nerve-wracking. Fixed income returns were abysmal — among the worst on record. The cause was bounding interest rates, which rose at an astonishing speed and consequently pulled down bond values.

But as exasperating as losses can be, the bond market’s current dynamics aren’t necessarily bad for long-term investors. In fact, they could be a blessing in disguise. Higher rates mean higher payouts over time, and with a long enough investment horizon, that could mean better total returns.

“Incurring the kind of short-term losses we did last year can be painful,” says Capital Group Private Client Services investment director Greg Singer. “But it’s important to remember that higher rates can ultimately be better for long-term investors.”

There are other implications for bondholders. Higher yields mean investors can shift some of their asset allocation from stocks to core bonds when pursuing their investment objectives; this can result in lower portfolio volatility and higher resilience to economic recessions and equity downswings if core bonds provide ballast as they did prior to 2022.

Of course, it will take some time for higher rates to make up for last year’s losses. Additionally, the Federal Reserve has said it’s still committed to fighting inflation, so further rate increases appear likely, and they could weigh on bonds in the near term.

Still, today’s dramatically higher yields offer opportunities that weren’t available even 15 months ago.

Simply put, higher rates mean higher bond payments — and potentially higher total returns.

Everything else being equal, higher bond payments are enticing. But the issue is whether they can make up for last year’s losses.

They can, says Singer. For long-term investors, higher yields not only have the potential to backfill 2022’s negative returns, but they could also result in a higher total return. However, Singer notes that this could take some time.

The chart on the next page highlights this. In one scenario, we examined the total return on a hypothetical $100,000 investment in bonds held for 10 years at a 1% yield, resulting in a final total value of $110,000. This is depicted by the green bars.

We compared that with the year-by-year growth of a similar hypothetical investment that also started with $100,000 in bonds at a 1% yield. In this second case, however, yields rise to 4% in the second year, pulling down the initial value of the investment. At its nadir, the second investment is worth $90,000 — a significant loss.

However, by Year 7, the higher bond payments have more than made up for that drop. At the end of 10 years, the higher yielding scenario is worth $118,160 — a 7.4% premium over the first scenario. This is depicted by the blue bars. If these conditions persisted, that gap would only grow.

It’s important to note that today’s higher yields don’t reflect a change in credit risk, as they’re purely the result of higher interest rates. Core bonds can still help preserve capital and diversify from equities; now, they’re also providing more income.

That’s not to say there aren’t potential risks. Rates could continue to move higher, resulting in more short-term pain for bondholders. Fortunately, higher yields provide some cushion against such losses; any further interest hikes won’t sting, point for point, as deeply as they did in 2022. That’s partly because a jump from, say, 1% to 3% is proportionally smaller than a jump from 4% to 6%, even though they’re both 2 percentage point increases. It’s also partly because a bond portfolio with a high yield has more room to provide a positive total return for the year if the value of those bonds falls.

Of course, any additional rate increases will also raise payouts, further setting up long-term investors for potentially strong returns over time.

Richer yields could change how some investors think about their finances and portfolios.

For investors, the impacts may extend well beyond more income.

Higher yields have implications for financial planning, for instance. They can make it easier to save for retirement, and they can help make portfolios go further for investors in that stage of life.

Investors concerned with resilience and volatility could opt to push their asset allocation toward core bonds and forsake some equity options while pursuing their growth objectives. The result could be similar total returns but with less downside exposure during recessions and stock market downturns, as well as more consistency in returns.

“With interest rate increases, the short-term pain really can come with longer-term benefit,” Singer stresses. “Rising interest rates are one of the risks of owning bonds, but the higher yields can also create better outcomes as we go forward.”