Fixed-income investments have generally been seen as a stable source of regular income in portfolios, but that approach hasn’t worked this year as the U.S. bond market experiences its worst year in decades, reports an article in The Wall Street Journal. U.S. Treasurys have plummeted roughly 34%, compared to a 21% fall in the S&P 500. So it’s no surprise that many investors have exited the bond market, but they could be missing out on opportunities, some strategists say.
The bond market might be close to its cyclical low, and even if it doesn’t rebound swiftly, bond investors could still see a solid stream of income from interest payments. And since yields have jumped so dramatically, now is the time to lock in those higher rates, with Mike Mulach of Morningstar telling The Journal, “This is a tremendous opportunity.” But there are still risks in the bond market, and the article offers a few pieces of advice for those to garner that extra income without taking on more risk:
Hang onto an individual bond to its maturity. Even though bonds lose their principal value as rates rise, an individual bond that’s held to its maturity will still earn back its initial outlay in addition to interest. The Journal advises working with an advisor or broker in order to select the right individual bond that will offer the right yield for your tax bracket.
Look at the total return instead of just the yield. Intermediate-maturity bond funds, which often people invest in since they have a lower outlay, tend to own more rate-sensitive bonds and don’t have a final maturity, unlike individual bonds. But once the Fed starts cutting rates, which many predict could happen early in 2023, those bonds should rebound. Investors who buy them should plan to hold them for several years, since intermediate funds usually have maturities ranging from 4 to 10 years. When selecting a fund to invest in, one rule of thumb is to match the “fund’s rate sensitivity…as shown on its fact sheet, with their own investment time horizon,” the article explains. Intermediate funds that are highly rated by Morningstar include Pimco Total Return and Vanguard Intermediate-term Bond.
Use the “laddering” variation approach. One strategy that’s a bit more measured would be to buy short-term securities, then reinvest the proceeds after they mature at higher rates. This approach works well so long as yields are still expected to rise, though of course getting the timing right could be a challenge. Less experienced investors might “be better off owning a floating-rate fund, whose yield automatically moves up or down with market rates,” according to John Kerschner of Janus Henderson Investors.
As rates go up, float higher. Some floating-rate funds hold bank loans payed to companies that have a lower credit rating, in order to claim higher rates. Those funds are now seeing yields rise as interest rates climb. However, these funds tend to be riskier than others and could be hit harder by a recession. Also, as soon as rates pass a cyclical peak, those floating-rate yields will begin to fall, so investors should consider trimming their exposure to these kinds of holdings when the Fed stops raising rates.
Lessen credit and rate risk. Focus on funds that zero in on the “1- to 3-year area of the investment-grade corporate debt market,” Lawrence Gillum of LPL Financial told The Journal. The losses that those funds have seen this year have been lower since they’re focused on maturities that are less-rate-sensitive, and their performance is expected to only get better as managers start replacing securities that have matured with fresh ones that are less expensive and have higher yields. Some of these funds come in low-cost ETF formats, or investors can choose an actively managed fund, where a skillful manager can weed through the expansive marketplace for the best opportunities.
———————————————
Validea runs stock and ETF models based on investment strategies with proven long-term track records. If you’re new to Validea, consider taking a look at our product overview or introductory videos.
