Is Now A Good Time To Buy Bonds
With the S&P 500 surrendering 18% last year, a major loss in the bond market was a rare and brutal shock to investors in mixed portfolios. It was the first time both indexes suffered double-digit losses in the same year since 1969.
is now a good time to buy bonds
So where does that leave bonds now? Potentially in a very attractive place. Many of the factors that hurt bonds in 2022 may work toward helping their performance in 2023, experts say. But that doesn't necessarily mean it's time to pile your portfolio into bonds.
"The Federal Reserve raised rates more than they have in 40 years. That caused massive losses inside of bonds," says Robert Gilliland, managing director at Concenture Wealth Management. "It's important to understand that bonds are generally secure, but not necessarily safe."
As a series of interest rate hikes eroded the value of bonds in 2022, it also did 2023 bond investors a couple of favors. For one, bonds are now offering more attractive interest payments to investors. At the beginning of 2022, a six-month Treasury bond paid an interest rate of 0.22%. The same bond today pays 4.76%.
Even if bonds may seem attractive right now, that doesn't mean long-term investors should abandon an all-stock portfolio in favor of adding bonds, says Pszenny. While the bond market suffered in 2022, so did the tech stock-heavy Nasdaq 100, an index with greater potential for high long-term returns.
In other words, if your original plans didn't include bonds, don't include them now. "Once you pick your asset allocation, unless something changes with your goals or time horizon, stick with your current allocation," Pszenny says.
If your plan already includes a bond allocation, consider moving to longer-dated bonds, Pszenny says. That's because bonds with longer maturities tend to be more sensitive to moves in interest rates. Should the Fed begin decreasing interest rates, long-term bonds will be the biggest beneficiaries, he says.
Some of your investing goals may be coming up sooner than a long-term goal like retirement, such as hosting a wedding or buying a house. Depending on how far out your goal is, you may want to hold a mix of stocks, bonds and cash.
I am a relatively new investor and have, up until now, only invested in stocks. I have been reading more about the bond market and am not sure if this is a good time to start investing in bonds now that interest rates have risen. Can you tell me more about investing in bonds so I can decide if it makes sense for me?
This is an incredibly timely question and one that I have been answering for many clients recently. Before we get into it though, I need to provide some context about interest rates and how they correspond to bonds.
When interest rates rise, bond prices go down in value. Most bonds pay a fixed coupon (i.e. interest payment) and if rates go up, the only way a fixed coupon can equate to a higher interest rate is if the investor pays less for the bond. A bond's duration is the measure of its price sensitivity in relation to a change in interest rates. Duration is a function of maturity, so the longer the maturity of a bond is, the longer its duration will be. The price of a longer-maturity bond is therefore more sensitive to a change in rates than that of a shorter maturity bond, assuming all other things are equal.
If you look at shortening the duration of the bonds you own, it will help to limit the potential damage that can happen if interest rates rise. If you can attempt to remove the interest rate risk by hedging, bonds become much more interesting.
There are investment strategies that concentrate on short duration, while others focus more on the products that hedge the interest rate of bonds, which essentially mitigates the risk and makes the move in rates much less impactful.
An example of an interest rate hedged bond strategy is when you invest in portfolios of investment-grade or high-yield bonds and include a built-in hedge to mitigate the impact of rising Treasury rates. In most cases, these products do their best to eliminate rate risk while short duration strategies only limit your exposure. You can also express this through asset classes such as floating rate investment grade bonds, bank loans and treasury inflation protected securities, or TIPS.
You will want to look for products that use the FTSE Corporate Investment Grade (Treasury Rate-Hedged) Index for investment grade bonds or the FTSE High Yield (Treasury Rate-Hedged) Index for high-yield bonds as a benchmark to help you make the right decision.
If you do want to purchase bonds via mutual fund or ETF, consider using a brokerage that doesn't charge commission fees, like Vanguard or Fidelity. Additionally a robo-advisor like Wealthfront or Betterment can construct a custom portfolio for you based on your risk tolerance, and generally they'll include bonds in the mix of assets that they choose for you.
In 2022, the Bloomberg Barclay's US Aggregate Bond Index, which represents the vast investible universe of US bonds, is set to do something it has never done before: lose value for the second year in a row.
However, as 2023 begins, bonds look poised to once again deliver their traditional virtues of reliable income, capital appreciation, and relatively low volatility. For the first time in decades, bond yields are high enough that income-seeking retirees can use them to help support a 4% withdrawal rate from their portfolios.
Because bond prices typically fall when interest rates rise, bond markets have long been sensitive to changes in rates by central banks. But they are also influenced by other factors such as the health of the economy and that of the companies and governments that issue bonds. Since the global financial crisis, though, the interest rate and asset purchase policies of the Fed and other central banks have become by far the most important forces acting upon the world's bond markets. In 2022, the focus of their policies shifted from supporting markets to trying to fight inflation and bond markets reacted badly.
That means angst about how interest rates might affect bond prices shouldn't obscure the fact that the return of rates to historically normal levels may present a long-awaited opportunity in bonds for those who seek income and principal protection. For years, as Managing Director of Asset Allocation Research Lisa Emsbo-Mattingly puts it, "The Fed had been financially repressing savers, especially retirees." Now, higher rates mean that retirees and savers may be able to earn attractive returns without taking much risk in 2023 and beyond.
Not only are yields up, prices of many high-quality bonds are down as a result of the 2022 selloff. That means opportunities exist for those with cash to buy relatively low-risk assets at bargain prices even as they pay yields that are higher than they have been in decades.
Emsbo-Mattingly expects the Fed to continue to raise the federal funds rate further until it has an impact on inflation. If inflation comes down closer to the 2.5% range where the Fed wants and expects it in 2023, real rates, which are bond yields minus the rate of inflation, could rise further into positive territory. This would help high-quality bonds to once again be meaningful contributors for many retirees who are looking to supplement Social Security, pensions, and other sources of income.
The opportunities provided by higher rates could be short-lived. Getting inflation under control is the focus of Fed policy in the months ahead, but the central bank also wants to make sure it has room to cut rates if the economy goes into recession, potentially in 2023. Rate cuts are the most powerful tools the Fed has to stimulate economic growth and the central bank wants to be able to make impactful cuts when necessary. That could mean that the opportunity to add low-risk, high-yielding bonds to your income strategy may not be there if you wait too long.
If you're considering individual bonds, you should know that the bond market is large and diverse and getting the best prices can be tricky. Fidelity can help by offering a wide range of ways to research bonds as well as professional help to construct a portfolio that reflects your needs, your tolerance for risk, and your time horizons.
In general, the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk, liquidity risk, call risk, and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so holding them until maturity to avoid losses caused by price volatility is not possible. Any fixed income security sold or redeemed prior to maturity may be subject to loss.
Lower yields - Treasury securities typically pay less interest than other securities in exchange for lower default or credit risk.Interest rate risk - Treasuries are susceptible to fluctuations in interest rates, with the degree of volatility increasing with the amount of time until maturity. As rates rise, prices will typically decline.Call risk - Some Treasury securities carry call provisions that allow the bonds to be retired prior to stated maturity. This typically occurs when rates fall.Inflation risk - With relatively low yields, income produced by Treasuries may be lower than the rate of inflation. This does not apply to TIPS, which are inflation protected.Credit or default risk - Investors need to be aware that all bonds have the risk of default. Investors should monitor current events, as well as the ratio of national debt to gross domestic product, Treasury yields, credit ratings, and the weaknesses of the dollar for signs that default risk may be rising.
Investors searching for good news have certainly found some: The latest consumer price index report suggested inflation may have peaked in October, and the Federal Reserve is perhaps now more likely to slow the pace of interest rate hikes. There was more reason for optimism last week, with investor sentiment, measured by the American Association of Individual Investors, at its highest levels since December 2021. 041b061a72