What impact does inflation have on bonds?

Rising inflation can erode the real return of bonds because bonds typically provide fixed interest payments to investors. When inflation increases, the purchasing power of those fixed payments declines. As a result, even though the nominal interest payments remain the same, the real value of those payments is diminished. This means that the actual return that investors receive, adjusted for inflation, decreases. For example, if a bond pays a 5% interest rate and inflation rises to 7%, the real return is effectively negative, as the investor's buying power decreases despite receiving interest payments. This understanding is crucial for investors who need to consider not just the nominal returns of their investments but also how inflation can affect their overall financial outcome.