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[A User Friendly View of the Above Picture](https://docs.google.com/spreadsheets/d/1yM5fdpQLABvCQYKSc2Ns5zI9zutUYbgfkl_HLLEkSto/edit?usp=sharing)
With the 2025 bond performance, there have been a number of [articles](https://www.moneytalksnews.com/why-boring-bond-etfs-are-the-surprise-portfolio-winner-for/) regarding [the best year since 2020](https://www.morningstar.com/markets/markets-brief-solid-year-bonds-6040-portfolios-too) and [how bonds are back.](https://www.morningstar.com/funds/bond-etfs-are-having-moment-heres-how-they-can-benefit-your-portfolio-2026)
I am not a fan of individual investors owning bonds, because I don't think they add value during the accumulation phase and cash is a better choice during the distribution phase (a/k/a retirement). However, in a previous lifetime working for a financial services company I analyzed bond portfolio returns, so I thought people might be interested in why certain bond funds, like BND, which indexes the total bond market, had the returns it did in 2025. In addition, what do the 2025 returns mean for potential future returns.
I did a prior post explaining bond yields in [July 2024](https://www.reddit.com/r/bonds/comments/1dwht6j/explaining_various_yields_for_bond_fundsetfs/?utm_source=share&utm_medium=web3x&utm_name=web3xcss&utm_term=1&utm_content=share_button) using BND as the example. Because I had access to those numbers, I have used the period from July 2024 to the end of 2025--18 months--to explain BND's returns over that period.
In general, there are five factors which impact bond fund returns. Some of these impact the dividend crediting rate, others the NAV (net asset value).
1. The overall coupon rates of the bonds held, a/k/a the average weighted coupon. The weighted coupon is the interest rate times the par value of the bond times the relative percentage of the value of the particular bond of the total value of the fund.
2. The discount or premium to par of the bonds held. Bonds at a rule do not sell at par, especially on the secondary market (even at issue there is usually either a discount or premium to par). When bonds are bought at a discount, say 95 cents on the dollar, the amortization of the discount as the bond approaches maturity increases the yield on the bond. When you buy a bond at a discount, say at 95, you are effectively buying $100 of par but paying only $95, and over time that $5 becomes yield of the fund, as reflected in the NAV.
3. Overall movement of interest rates. As rates fall, NAVs tend to increase, and vice versa.
4. Defaults, either in corporate bonds, or in collateralized bonds like CMOs (collateralized mortgage obligations) or CDO's (collateralized debt obligations)--or in foreign debt, in some cases--general reduce the NAVs. For example, a GNMA fund, which owns many home mortgages, is impacted when housing loans go south (like in 2008 and the aftermath).
5. Prepayment of CMOs, CDOs, and the like. If the pool of loans underlying the collaterialized bonds pays either sooner or later than projected, that can impact bond fund performance.
Between 7/1/2024 and 12/31/2025, BND had a return of 9.77%, according to the portfolio analyzer I use. The returns were 2.51% for the half year of 2024. and 7.08% for 2025 (full year). The price of BND, adjusted for dividends, went from $67.47 to $74.07, which is a 9.78% increase--confirming the analyzer.
The return had two components. First, was the dividends received over that 18 month period, which totalled $4.43, or roughly 6.20% for the 18 months (roughly 4.14% on an annual basis). The second component was the price change from $71.45 to $74.07, or a 3.67% increase. Those two don't add exactly to the 9.77%, but it's close enough for these purposes.
Part of the change in the NAV from $71.45 to $74.07 was the closing of the discount on the bonds. As of 5/31/2024 (the Vanguard data lags by a month) the discount was 10.7%; that closed to 4% by the end of 2025. In part because of the amortization of the initial discount, but in large part because interest rates, as measured by the 10 year treasury, dropped from 4.43% to 4.16%. The drop in rates was the biggest factor in the 7.08% return for 2025.
Over the period, the weighted coupon did increase from 3.4% to 3.8%, as higher yielding bonds replaced lower yielding bonds. That is a positive for returns going forward.
However, the closing of the discount from 10.7% to 4% ALSO lowered the expected YTM from 5.1% as of 7/1/2024 to 4.3% at the end of 2025. In effect, the lower rate at the end of the year accelerated the recognition of the discount, pushing what the fund holder would have earned in future years into 2025.
So while the returns for 2025 look good, and the weighted coupon increased, the expected returns going forward actually dropped somewhat substantially, lowering expected future returns. I suggest if you are considering investing in bonds in 2026, you understand that the 7% return of 2025 was caused by specific factors, and may not be reproduced in future years.
Hope you find this helpful.