Does it make sense to invest in bond funds?
Investing in bond funds can make it easier to achieve broad diversification with a lower dollar commitment, but offers less control.
The key benefits to owning bond funds are: Greater diversification per dollar invested: It is much easier to achieve a diversified bond portfolio per dollar invested using a fund, because you obtain exposure to a basket of bonds within the fund.
The disadvantages of bond funds include higher management fees, the uncertainty created with tax bills, and exposure to interest rate changes.
Expecting another strong year in 2024
Following large front-loaded new issue supply, EM IG spreads are now at attractive levels versus U.S. credit, setting up EM debt for outperformance. Our 2024 macroeconomic base case features slowing inflation and growth cushioned by Fed rate cuts.
For many investors, investing in the right bond funds can be a better option than holding a portfolio of individual bonds. Bond ETFs can provide better diversification — often for a lower cost — can offer higher liquidity, and can be easier to implement.
What causes bond prices to fall? Bond prices move in inverse fashion to interest rates, reflecting an important bond investing consideration known as interest rate risk. If bond yields decline, the value of bonds already on the market move higher. If bond yields rise, existing bonds lose value.
As for fixed income, we expect a strong bounce-back year to play out over the course of 2024. When bond yields are high, the income earned is often enough to offset most price fluctuations. In fact, for the 10-year Treasury to deliver a negative return in 2024, the yield would have to rise to 5.3 percent.
Bonds, particularly government bonds, are often seen as safer investments during a recession due to their regular interest payments and the fact that they are less volatile compared to other assets like stocks.
Key Takeaways
Bonds are often touted as less risky than stocks—and for the most part, they are—but that does not mean you cannot lose money owning bonds. Bond prices decline when interest rates rise, when the issuer experiences a negative credit event, or as market liquidity dries up.
Bonds are generally considered a less-risky complement to the volatility of stocks in an investment portfolio. U.S. Treasurys, and specifically Treasury bills and Treasury notes, are the benchmark for a nearly risk-free investment if held to maturity.
Should you buy bonds when interest rates are high?
When rates go up, bond prices typically go down, and when interest rates decline, bond prices typically rise. This is a fundamental principle of bond investing, which leaves investors exposed to interest rate risk—the risk that an investment's value will fluctuate due to changes in interest rates.
Unless you are set on holding your bonds until maturity despite the upcoming availability of more lucrative options, a looming interest rate hike should be a clear sell signal.
| Fund | Expense ratio |
|---|---|
| Vanguard Total Bond Market Index Fund Admiral Shares (ticker: VBTLX) | 0.05% |
| Vanguard Total International Bond ETF (BNDX) | 0.07% |
| Vanguard Short-Term Treasury ETF (VGSH) | 0.04% |
| Vanguard Ultra-Short Bond ETF (VUSB) | 0.10% |
Bond prices have an inverse relationship with interest rates. This means that when interest rates go up, bond prices go down and when interest rates go down, bond prices go up.
Stocks offer the potential for higher returns than bonds but also come with higher risks. Bonds generally offer fairly reliable returns and are better suited for risk-averse investors.
In return for buying the bonds, the investor – or bondholder– receives periodic interest payments known as coupons. The coupon payments, which may be made quarterly, twice yearly or annually, are expected to provide regular, predictable income to the investor..
| Face Value | Purchase Amount | 30-Year Value (Purchased May 1990) |
|---|---|---|
| $50 Bond | $100 | $207.36 |
| $100 Bond | $200 | $414.72 |
| $500 Bond | $400 | $1,036.80 |
| $1,000 Bond | $800 | $2,073.60 |
Most bonds pay a fixed interest rate that becomes more attractive if interest rates fall, driving up demand and the price of the bond. Conversely, if interest rates rise, investors will no longer prefer the lower fixed interest rate paid by a bond, resulting in a decline in its price.
| Pros | Cons |
|---|---|
| Bond funds are typically easier to buy and sell than individual bonds. | Less predictable future market value. |
| Monthly income. | No control over capital gains and cost basis. |
| Low minimum investment. | |
| Automatically reinvest interest payments. |
Ultimately, holding bonds in a portfolio can help with diversification. Often, portfolio solutions (investments made up of carefully selected and managed mutual funds and/or exchange-traded funds) will include a fixed income component depending on how much risk you're comfortable with or when you will need your money.
What is the best mutual fund to invest in in 2024?
- Fidelity 500 Index Fund. : Best overall.
- Fidelity Large Cap Growth Index Fund. : Best for growth investors.
- Fidelity Investment Grade Bond Fund. ...
- Fidelity Total Bond Fund. ...
- Vanguard Wellesley Income Fund Investor Shares. ...
- Schwab Fundamental US Large Company Index Fund. ...
- Schwab S&P 500 Index Fund. ...
- Vanguard High-Yield Tax-Exempt Fund.
- Bonds and bond ETFs.
- Dividend-paying stocks and ETFs.
- Master limited partnerships.
- Real estate investment trusts.
- Annuities.
Cash: Offers liquidity, allowing you to cover expenses or seize investment opportunities. Property: Can provide rental income and potential long-term appreciation, but selling might be difficult during an economic downturn.
Those with retirement quickly approaching may want to consider rolling any of their old 401(k) accounts into either IRAs (which offer more investment options) or annuities (which can provide a set rate of return during uncertain times).
During a recession, investing in cash and cash equivalents becomes a strategic choice for investors who are hoping to preserve their capital and maintain liquidity. Cash equivalents include short-term, highly liquid assets with minimal risk, such as Treasury bills, money market funds and certificates of deposit.
