Although rising interest rates have created analysis should give long-term investors reasons near-term pain for fixed income investors, to be optimistic about the prospects of their we expect that those with sufficiently long fixed income portfolios. investment horizons will be better off in end-of- period wealth terms by the end of the decade Against a backdrop of rapidly rising rates, our than if they had just realized our return forecast fixed income return outlook for the next decade from the end of last year (Figure II-4). This is (Figure II-5a) is significantly better than last because of the effect of duration. When interest year’s projections, at 4.1%–5.1%, based on more rates rise, bonds reprice lower immediately. attractive valuations (Figure II-5b). Expected However, cash flows can then be reinvested at returns for non-U.S. bonds in local currency are higher rates. Given enough time, the increased lower than those of U.S. bonds in light of the income from higher coupon payments will offset relatively lower yields in non-U.S. developed the price decline, and an investor’s total return markets, but the differences are negligible once should increase. we account for currency impacts. Further, the diversification through exposure to hedged Of course, higher returns are not guaranteed. non-U.S. bonds should help offset some risk The median of this analysis is informed by the specific to the U.S. fixed income markets (Philips trajectory of yields implied by the forward yield et al., 2014). Broad U.S. investment-grade bonds curve. Figure II-4 shows that there is a possibility should outperform U.S. Treasury bonds by that investors may not have higher wealth at the 1.1 percentage points on an annualized basis. end of the decade because interest rates continue Importantly, while recent returns have called to rise throughout the next decade. But this into question fixed income’s role in portfolios, we continue to believe its inclusion is warranted as a 8 portfolio stabilizer and a long-term diversifier. FIGURE II-4 We expect investors to be better off because, not in spite, of the sell-off $  ,   y a f M Return forecast as of s o December ,  d a e t s e v  n  i   f $ Return forecast as of e o u l September ,  a V        Notes: The chart shows actual returns for the Bloomberg U.S. Aggregate Bond Index along with Vanguard’s forecast for cumulative returns over the subsequent 10 years as of December 31, 2021, and September 30, 2022. The dotted lines represent the 10th and 90th percentiles of the forecasted distribution. Data are as of September 30, 2022. Sources: Vanguard calculations and Bloomberg, as of September 30, 2022. IMPORTANT: The projections and other information generated by the VCMM regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Distribution of return outcomes from VCMM are derived from 10,000 simulations for each modeled asset class. Simulations as of December 31, 2021, and September 30, 2022. Results from the model may vary with each use and over time. Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index. 8 Despite the historic sell-off of fixed income in 2022, its inclusion in the portfolio still improved results, because bonds are a lower-volatility asset. Our research (Wu et al., 2021) finds that asset allocation matters more than correlation regime when estimating outcomes over a long-term horizon. 40