Bond yields are surging -- here's why investors should care

What's behind the stock market sell-off?

While the attention of investors was riveted by the sharp selloff in stocks earlier this week, another key turn in financial markets is worth paying attention to: The spike in bond yields.   

The return investors earn on the U.S. 10-year Treasury bond recently jumped to its highest level since 2011. That surge is noteworthy as a possible signal of where the economy is headed, while for average investors it raises the question of what, if anything, they should do to keep their money safe as the markets heave. Here's what you should know about the sometimes confusing relationship between stocks and bonds, and what that means for your portfolio.

A decade of low bond yields is ending

The benchmark U.S. 10-year Treasury bond usually offers a lower return, or yield, than a typical index fund that tracks the S&P 500. For nearly a decade after the 2008 financial crisis, the Federal Reserve's policy of low interest rates kept bond yields low, which hurt savers and those looking to diversify their portfolio. 

Exceptionally low bond yields also encouraged many investors to put their money elsewhere in search of higher returns. Some bought longer-term bonds, some invested overseas and others poured their money into the equity markets.

Flash forward to today: The economy is on a roll, with growth in the nation's gross domestic product topping 4 percent between April and June and on pace to eclipse 3 percent in the third quarter. Unemployment in September fell to its lowest rate in nearly half a century. Even worker wages are finally showing signs of life after idling for most of the recovery that followed the housing crash. 

Interest rates are rising -- get used to it

All of that is great news for Americans. But it also means the Fed is likely to continue raising interest rates as it taps the monetary brakes to keep inflation in check and prevent the broader economy from overheating, which can trigger a recession. When interest rates rise, bond yields typically do as well as investors pull money out of stocks and move them into bonds to capitalize on the higher (and safer) returns. 

That dynamic played out in the market carnage this week. Strong U.S. economic data strengthened investors' conviction that the Fed will keep hiking rates -- and maybe even a bit faster than people had expected. As a result, bond yields rose (and bond prices fell, since they move inversely to yields). The quick jump in yields in turn spooked equity investors amid fears that rising rates could dent corporate profits, slow economic growth and lead to a slump in stocks.

"Investors are laser-focused on rising bond yields as this has caused agita for both fixed-income as well as equity investors over the past week," Daniel Ives, managing director of equity research at Wedbush Securities, said in an email to CBS MoneyWatch.

So what does this mean for investors?

Do the fatter returns on bonds mean investors should dive in? Not necessarily.

Savita Subramanian, head of equity strategy for Bank of America Merrill Lynch, notes that although bond yields are rising, they're still not at the level that usually invites a critical mass of investors to rotate out of stocks into bonds. Over the last 30 years or so, bond yields had to hit at least 5 percent to lure equity investors.

In short, bond prices could have further to fall. "I still think the biggest risk right now is buying bonds," she said. "Because bond prices go down when yields go up so, wait until you can get a healthier return."

For those who are investing over a long time horizon, say in a 401(k) plan, experts say it's best to keep your portfolio balanced and diversified among different asset classes. 

Dow tumbles more than 800 points over interest rate worries

As usual, how much risk you take on -- your balance of stocks to bonds, for example, as well as individual holdings -- depends on your financial goals. If you're looking to make changes in a volatile market, consider your age, when you'll need the money and your risk tolerance, including how well you can stomach the ups and downs. 

"Diversification is like a shock absorber to weather the storms in the market," Jeanne Thompson, senior vice president at Fidelity Workplace Investing, told CBS MoneyWatch. 

That looks different for each person, and in the case of saving and investing for retirement, it's heavily influenced by an investor's age. Using target-date funds as a benchmark, Thompson said a person at age 25 might have a fund that's about 10 percent bond funds and the rest in a mix of equities -- a more growth-oriented portfolio. At age 60, the picture changes to 40 percent bonds, 7 percent cash and a mix of equities. 

Whatever the case, Thompson said investors should make sure their portfolio is appropriately balanced at regular intervals. Also key, though it can be difficult when stocks are swinging wildly: If you're investing for the long-term, don't get caught up in the market's daily up and downs.

Said Thompson: "We suggest that people check their portfolios at least once or twice a year to check to make sure that you are well diversified -- that you have the comfort and the time to sit it out and ride it out until it comes back."