What Happened to Stocks and Bond ETFs in 2022?

Coming into 2022, the 10 year Treasury yielded about 1.5% and the federal funds rate was effectively zero. Inflation, which the Fed had called transitory through most of 2021, ran above 7%. Over the course of 2022 the Fed raised rates seven times, taking the funds rate from a range of 0% to 0.25% up to 4.25% to 4.50%, the fastest tightening cycle since the early 1980s.

Bond prices move inversely to yields, and the size of the move is governed by duration. When the 10 year yield roughly doubled, every bond fund repriced downward in proportion to how much interest rate risk it carried. That is why the damage was so uneven: ultra short and short term bond funds lost low single digits, intermediate core bond funds lost around 13%, and long term Treasury index funds lost close to 30%. Investors who owned a total bond market fund and thought of it as the safe money were surprised. Investors who owned long Treasuries as a hedge against a stock crash got the worst of both.

Stocks fell for a related reason. Higher discount rates reduce the present value of future earnings, and the companies whose value sits furthest in the future got repriced hardest. The Russell 1000 Growth index fell about 29% in 2022 while the Russell 1000 Value index fell about 8%, a spread of roughly 21 percentage points in a single year. The Nasdaq Composite fell about 33%. Nothing about the underlying businesses changed that much in twelve months. The rate used to value them did.

This is the part that matters for portfolio construction. Stocks and bonds have historically offset each other because the typical bad event was a recession, which hurts stocks and helps bonds as the Fed cuts rates. In 2022 the bad event was inflation, and inflation hurts both. Correlation between stocks and bonds is not a fixed property of the two asset classes. It depends on what is driving the economy.

A conventional 60/40 portfolio lost roughly 16% in 2022, its worst result since the 1930s. It then recovered. Someone who held through 2022 and reinvested was made whole within a couple of years. Someone who was drawing 5% a year out of that same portfolio in their first year of retirement was not in the same position, which is the entire point of sequence of returns risk.

The one genuine silver lining: bond yields reset higher. A bond portfolio yielding 1.5% has almost no cushion and almost no expected return. A bond portfolio yielding 4% to 5% has both. The price of getting there was paid in 2022, and the investors who sold into the drawdown paid it without collecting the benefit.

Know the duration of the bonds you own. This is the single most actionable takeaway from 2022. Two investors who both describe their holdings as bonds can have wildly different exposure. If you cannot state the effective duration of your bond funds, you do not know how much interest rate risk you are carrying.

Match duration to when you actually need the money. Money you plan to spend in the next two to three years does not belong in a fund with a six year duration, and it certainly does not belong in a long term Treasury fund. This is not a market call. It is arithmetic.

Stop treating bonds as a monolithic safe sleeve. In a retirement portfolio, the bond allocation does at least two different jobs: funding near term withdrawals and hedging equity risk. Those jobs want different durations. Collapsing them into a single total bond market fund is convenient but imprecise.

If you were still working in 2022, the drawdown was mostly noise. If you were withdrawing, it was a real and permanent reduction in the capital base that funds the rest of your life. The same market return produces very different outcomes depending on whether you are contributing or spending.

For taxable accounts, 2022 was a tax planning opportunity that many households missed. Large unrealized losses in bond funds were harvestable, and those harvested losses can offset capital gains indefinitely into the future. If you held through 2022 in a taxable brokerage account and never harvested, that is a permanent missed deduction.

• Selling bond funds at the bottom of 2022 and moving to cash, which locked in the price loss and forfeited the higher yields that were the whole reason the prices fell.
• Assuming a total bond market fund is low risk without ever checking its duration.
• Owning long term Treasuries as a stock market hedge without understanding that they hedge recession risk, not inflation risk.
• Concluding from one year that diversification does not work, and abandoning bonds entirely right before they started paying a real yield again.
• Failing to harvest losses in taxable bond and stock positions during the drawdown, permanently giving up deductions that had no expiration date.
• Retiring in 2022 on a withdrawal plan that had only been stress tested against equity drawdowns, not against a simultaneous stock and bond decline.