The Bond Sell-Off Is Rattling the Stock Market. Here's What History Says Investors Should Do.

The bond market is sending another warning to stock investors. Long-term Treasury yields have surged, with the 30-year yield recently touching its highest level since 2007. The 10-year Treasury yield is also pushing toward its own multi-year high.

Stocks and bonds have responded with some volatility. Treasury Secretary Scott Bessent announced a government intervention that resulted in it buying back bonds on the long end of the curve. But that proved to have little impact on the direction of rates.

That creates a potential problem for investors. If rising yields continue pressuring both stocks and bonds, is it time to reduce some exposure now?

History suggests long-term investors should probably do the opposite. Remain invested, keep a long-term view, and avoid letting short-term volatility alter a strategy that's built for wealth creation over decades.

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Why the bond sell-off is hitting stocks

Bond prices and yields move in opposite directions, so a yield spike can send prices sharply lower. We've seen this especially in long-term Treasuries lately. That's important for stocks for several reasons.

First, higher Treasury yields give investors a more attractive alternative to stocks. If they can capture higher yields from more conservative fixed-income options, stocks begin to look less attractive.

Higher yields also translate into higher borrowing costs for businesses and consumers. That's particularly relevant today because huge spending on artificial intelligence (AI) infrastructure is increasingly being financed with debt.

Lastly, higher interest rates can make future corporate earnings less valuable in today's dollars. That can be particularly problematic for more expensive growth stocks whose valuations depend heavily on profits expected years into the future.

Those are very real risks today. Rising yields can hurt stocks, but there's an important difference between recognizing market risks and trying to predict what stocks will do next in the short term.

History says volatility is the price of admission for investing in stocks

The S&P 500 has produced an average annual return of roughly 10% over its long-term history. But to earn those returns, you would have had to ride out a number of bear markets, recessions, and major economic events.

The stagflation of the 1970s, the tech crash at the beginning of this century, the financial crisis, and the pandemic all resulted in deep drawdowns for stocks. Not to mention the number of interest rate, geopolitical, and economic slowdown events along the way.

Yet the stock market continued to create long-term wealth for investors who rode out the volatility. Even more importantly, significant declines aren't unusual. Since 1980, the S&P 500 has suffered an average intra-year decline of about 14%. But despite this, the index was able to post positive calendar year returns about 75% of the time.

That's two distinct narratives that usually aren't viewed together. Investors regularly experience double-digit declines even during periods where stocks have generated double-digit average annual gains.

Volatility isn't a signal that indicates a long-term investment strategy is broken. It's often simply the price you pay to try to capture the stock market's long-term returns.

Here's what investors should do now

Nobody knows how the current bond sell-off will end. Yields could keep climbing as investors grow more concerned about inflation and fiscal deficits. Or an end to the Iran war could ease inflationary pressures and calm worries about an economic slowdown.

The thing is that long-term investors don't need to try to figure out which outcome will happen.

Those with decades before they'll need their money can stay the course, continue to add to their investment accounts regularly, and stay diversified. A low-cost S&P 500 index fund, such as the Vanguard S&P 500 ETF, is one simple way to do that.

Those approaching retirement may reasonably want less exposure to potential market and portfolio volatility. But for those with long time horizons, trying to get in and out of the stock market at the right time usually just creates even bigger risks.

The S&P 500 has survived plenty of scary markets over its history. Yet it continues to hit new all-time highs. History suggests you're better off simply letting the long-term power of compounding do its thing.

David Dierking has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.