Why Safe Bonds Can Still Lose Money

Here's a question that sounds like a trick. You lend money to the Australian government, about as safe a borrower as exists, and yet the thing you hold can fall in value. How? And why does every finance commentator keep saying bond prices and yields move in opposite directions? It matters because bonds sit quietly behind a lot of ordinary financial life. They shape what the Reserve Bank can do, they show up in the headlines when markets wobble, and they're tucked inside bond ETFs and inside many Australian super funds. So if your retirement savings are in a typical fund, you probably own some, whether you know it or not. One note before we start. This is general education, not personal financial advice. Everyone's circumstances differ, and the historical examples describe what happened, not what will happen. Let's build this up one idea at a time. First, what a bond actually is. When you buy a bond, you agree to lend your money to a government or a company. In return, they promise to pay you interest for a set period, and then repay the original amount at the end. Three terms matter. Face value is the amount repaid when the bond comes due. The coupon is the fixed interest paid each year. Maturity is the due date. Here's a concrete case. Take a bond with a face value of one hundred dollars and a coupon of four per cent. It pays you four dollars a year. In Australia, that's usually split into two payments, so two dollars every six months. It keeps doing that until maturity, when you get your one hundred dollars back. Exchange-traded Australian government bond units are typically set at that same one-hundred-dollar face value, which makes the arithmetic easy to follow. The second idea is one that trips up almost every beginner. The coupon is not the same as the yield. The coupon is baked into the bond's terms. On a standard fixed-rate bond, which is the kind this episode is about, it never changes. The yield is different. It's the return you expect to receive each year over the bond's term to maturity, given the price you paid, the payments still to come, and the repayment at the end. Why would those differ? Because you don't have to buy a bond at its face value. Bonds trade on the market, and their prices float. If you pay more than face value, your yield comes out lower than the coupon. If you pay less, your yield comes out higher. Take a bond trading at ninety-five, meaning ninety-five dollars for every hundred of face value. Say it has a three per cent coupon and three years left. You pay ninety-five, you collect the three-dollar coupons, and at the end you're repaid a hundred. That extra five dollars is a gain on top of the interest. So your yield is more than three per cent. Same coupon, different price, different yield. Hold onto that, because it's the doorway to the main idea. Third, the seesaw itself. The coupon is fixed. But the interest rate the market demands from new bonds keeps changing. So how does an existing bond stay competitive? Its price moves. The Reserve Bank gives a clean example. Imagine a ten-year bond with a face value of one hundred dollars, paying two per cent, so two dollars a year. Now suppose market yields fall to one per cent. New bonds are paying less than yours. Your two dollars a year is suddenly attractive. Buyers will pay more to own it. The RBA's worked figure is that the price rises to one hundred and nine dollars and fifty cents, and at that price, a buyer's return works out to about one per cent. Now run it the other way, using an example from a US state financial regulator. Suppose you hold a bond paying five per cent, and market rates double to ten per cent. Nobody wants your five per cent bond at full price when they can get ten elsewhere. So its value drops until the deal looks fair to a new buyer. That's the seesaw. Yields fall, price rises. Yields rise, price falls. The coupon stays put, so the price is the only thing that can give. And notice the logic isn't mysterious. It's just buyers shopping around. Fourth, duration. This is the idea of how sensitive a bond's price is to changes in interest rates. The general pattern is that longer bonds swing more than shorter ones. That makes sense when you think about it. If you're locked into a low coupon for ten years, you're missing out on better rates for a long time. If it's only two years, you'll be free soon. One of the sources offers a rule of thumb. A ten-year bond might fall about eight per cent for every one per cent rise in yields. A two-year bond might fall about two per cent. Those are illustrations, not guarantees. I'll come back to that in a moment, because the sources are loose on this point. Fifth, why a safe government bond can still fall in price. This is the part that surprises people. When we call a government bond safe, we mean low credit risk. The chance the government fails to pay you is very small. But credit risk is only one kind of risk. Price risk is another. The price you could get today if you sold can drop even when the issuer is perfectly sound. And here's the reassuring part. That loss only becomes real if you sell. If you hold the bond to maturity, and assuming no default, you get your face value back no matter what the price did in between. The dip is on paper unless you cash out early. The recent past shows how this plays out. Between 2022 and 2023, the RBA's cash rate rose from 0.1 per cent to 4.35 per cent. Investors who sold bonds early in that period locked in capital losses, even though the issuer was the government. Same safe borrower, falling prices, because rates went up. Sixth, how this connects to the Reserve Bank and to what you hear described as bond sell-offs. The RBA's cash rate is the starting point of the yield curve, which is the line showing yields across different bond lengths. But the cash rate doesn't dictate bond yields. Bond yields are set by the market, and they can move in anticipation of what the central bank is expected to do, before it does anything. It's also worth knowing that the Australian ten-year bond yield is a different thing from the cash rate, and different again from your mortgage rate. They're related, but they're not the same number. So what's a bond sell-off? It's just the seesaw in motion. Investors sell, prices fall, and yields rise as buyers demand higher returns. Nothing more exotic than that. The Reserve Bank can also lean on this directly. In 2020, it targeted a three-year government bond yield of about twenty-five basis points, which is a quarter of one per cent. To hold the yield there, it bought just over forty billion dollars of Australian government bonds. Buying pushes prices up and yields down. So that episode shows a central bank steering yields on purpose, using the very seesaw we've been describing. Seventh, bond ETFs and super funds, where the seesaw shows up in bulk. Picture a single bond with a maturity date in 2030. As that date approaches, its price drifts back toward one hundred dollars, and on the day it matures you receive the face value. A bond ETF holds a whole portfolio of bonds, and it never reaches a date like that. As older bonds mature, the fund keeps holding or buying others, so its unit price rises and falls with interest rates and there's no moment when it simply hands back your original amount. It also charges ongoing fees. Typical annual fees for bond ETFs run about 0.15 to 0.35 per cent, according to one of the sources. Super funds are different again. They hold fixed interest as one slice of a wider mix. When yields rise, the market value of that slice can fall. But one slice doesn't decide the whole result. Shares, property and other assets matter too, so rising bond yields don't by themselves determine your overall super return. It depends on the asset mix. Now, the limits of what we can say with confidence. On duration, the sources describe it only loosely and give no formula. The eight per cent and two per cent figures are rules of thumb, flagged with the word might, not calculated examples. Treat them as a feel for the pattern, not as precise predictions. Bonds also don't always cushion shares. In March 2020, during what's called the dash for cash, government bond prices fell alongside shares before the RBA stepped in. Government bonds were still more resilient than shares overall, as the Australian share market fell around thirty-five per cent to late March. But they didn't offer perfect protection. On super, no source here measures how much bond losses affected Australian super balances. So the real-world effect on members is unquantified in this research, and again, it depends on the mix. On bond ETFs, the evidence is thin beyond the point that they don't behave like a single bond, and one source on this is US-focused. Finally, one yield range quoted in the research, four to eight and a half per cent, comes from a product directory, not a neutral source, so I've left it out of the main story and would treat it with caution. So here's the recap. A bond is a loan with a fixed coupon and a face value repaid at maturity, so when market yields rise its price falls, and when yields fall its price rises. Longer bonds swing more, and even low-credit-risk government bonds can lose market value if you sell before maturity. The same seesaw shows up in RBA decisions, bond sell-offs, bond ETFs and the fixed-interest slice of super.