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We all remember the 2022 bond collapse, triggered by rising interest rates. Most of us were caught out, a supposedly safe asset class posting double-digit losses. Some of those bond funds are still slightly underwater four years later. Which brings me to a question worth thinking about.
Right now, Treasury Inflation-Protected Securities (TIPS) are offering guaranteed real returns of roughly 2-3% above inflation. That’s a compelling, ultra-safe option for liability matching in retirement, and I think most people would do well to look into it. The catch: none of us have unlimited capital. For many, the money to fund that TIPS allocation would have to come from selling bond funds that are still sitting at a loss.
So the real question is this: does it make sense to realize a loss now in order to lock in today’s TIPS environment?
My personal opinion, for what it’s worth: don’t anchor to the purchase price. What you paid for those bond funds in 2021 is gone, and it has zero bearing on whether today’s decision is a good one. The only question that matters is forward-looking: is this capital better off in TIPS than in what you’re currently holding?
Framed that way, the “loss” stops being a loss at all. You’re not losing money by selling, you already lost it when rates rose in 2022. The price already reflects that. What you’re actually doing now is trading an uncertain, drifting recovery for a locked-in, inflation-protected return.
To my way of thinking, that’s not giving something up. It’s possibly an upgrade.
There’s a second reason this makes sense beyond the psychology: compare current yields, not prices. Your bond fund’s price already adjusted to the higher-rate world, so the real comparison isn’t “I’m down X%, do I cut my losses.” It’s “what yield is this fund actually offering me now, versus what TIPS are offering.” Once you strip out the emotional weight of the purchase price, it’s just a straightforward yield comparison.
Often, that comparison favors moving.
If you’re holding in a taxable account, there’s a possible third reason to act now rather than later: realizing that loss can offset gains elsewhere. The tax code is quite literally rewarding you for doing the thing your instincts are resisting. The sunk cost fallacy is fighting you at exactly the moment the numbers are on your side.
So what do you think of my reasoning, does it make sense or am I missing something obvious? I’m not a financial advisor but it seems to me getting hung up on any bond losses shouldn’t be the driver of your decision making.
I won’t get into the technical details of bonds and TIPS, because I’m horribly ignorant!
But thinking about the original buy price for any asset isn’t the point, and is at the essence of the “sunk cost” fallacy. The only thing that matters is how to best invest any given dollar today, regardless of what happened in the past.
I get that it feels bad to crystallise a loss, but staying in a sub-optimal asset isn’t going to make it any better.
On that note, we just sold a house that we lost lots of money on (long story with financial and non-financial elements). But we doubted that it was going to better in the near future, and the equity in the house was better put to other uses. So we sucked up the loss and moved on.
Mark,
In 2024 I switched from an intermediate to a short term bond fund in my taxable account. I decided it was not worth waiting for the intermediate bond fund to get back to equal. This money was originally put aside in 2019 to pay for new cars over the years, and a porch addition in 2028 so it seemed to make sense at the time. We got one vehicle paid for before the 2022 bond crash. The switch to short term bond fund was because we were much closer to utilizing the money. Now I told my wife she has to keep me alive for 5 more years to get the loss back in it’s entirety (this is another break for affluent investors in the US, we can get our loses back through a annual 3K tax deduction). Now my bonds are evenly split in our portfolio, 1/3 each in intermediate, short term, and short term TIPS.
Prior to moving our IRAs to Fidelity, I had primarily been using a balanced fund, so never had to give any thought to allocations, other than 60/40 vs 70/30. When deciding on ETFs at Fidelity, I looked at the total bond ETFs and thought, yikes, these things still haven’t recovered to their 2021 levels. So, partially based on the opinions of my fellow HumbleDollar nerds, I made Vanguard’s VTIP my main bond position. I also have a five year CD ladder, which all by itself can protect me from a lost decade.
Just for fun, I have a small stake in Fidelity’s FAGIX, which is a high yield play. It probably has a higher correlation with equities, so I don’t really consider this a defensive device.
And who’s to say those bond funds won’t take another nasty hit in the future. So, yes, I’d eat the loss and switch to TIPs.
I’m not convinced that selling a bond fund in a taxable account and replacing it with a TIPS is a good idea. The taxation of individual TIPS in a taxable account involves paying taxes on phantom income. In other words, there is no current cash flow for this income. If you are speaking about a TIPS bond fund, you could have the same issues of the fund declining in value as rates rise. TIPs generally belong in tax deferred or tax paid accounts.