The main factors influencing a bond’s duration are time to maturity and its coupon rate. In general, the longer the time to maturity, the higher the duration. The higher the bond’s coupon rate, the lower the duration, all else being equal. For example:
| ETF | Ticker | Effective Duration | Effective Maturity |
| Vanguard Short-Term Bond ETF | BSV | 2.64 years | 2.80 years |
| Vanguard Long-Term Bond ETF | BLV | 14.13 years | 22.60 years |
An investor in BSV can expect a 2.64% increase in the value of the fund due to a 1% decline in interest rates. Likewise, an investor in BLV could expect a 14.13% increase in the fund as a result of a 1% decline in interest rates. These of are approximations, of course, and don’t include any market or other factors that could influence the price of an ETF over time. Also, duration is an estimate, not a set number.
For clients invested in individual bonds or bond funds, should interest rates decline as many predict, aided by any Fed interest rate cuts, they could experience potentially significant increases in the value of their bonds or bond funds, especially if they are on the longer end of the duration spectrum.
Bond and CD ladders
With interest rates at high levels, this can be a good time to lock in these rates with individual bonds orcertificates where appropriate. Keil, the financial advisor, said that the bond market is telling us to lock in before the Fed starts cutting.
A strategy to consider is building a bond ladder or a CD ladder if that fits into a client’s overall financial planning and investment strategy. Using a ladder allows clients to lock in today’s relatively high rates without worrying about where rates go as long as they hold the bonds or CDs until maturity. While bonds seem to get more press, a recent article by Fidelity indicated that some CD rates are very favorable compared with some riskier bonds.
As each holding on the ladder matures, clients can decide how to reinvest the money. This could be at the longer end of the ladder or elsewhere. In the meantime, clients benefit from the interest earned during the holding period.
While the Fed has indicated that it will be cutting rates, there is no guarantee as to when these cuts will start and how extensive they will be. Experts’ opinions vary on this topic and also on inflation and the overall economy. Both areas can influence the direction of interest rates.
A risk, especially for clients using ETFs and mutual funds to invest in bonds, is to know when rate cuts have run their course. At that point, the risk, especially with longer duration holdings, is that rates could head back up. That could cause a decline in the value of these funds, potentially eroding some or all of the profits made from price increases fueled by declining interest rates.
Most clients likely have a target allocation for bonds and fixed income within their overall asset allocation. While it can make sense to direct some of this allocation to longer duration bonds or other areas that are expected to benefit from falling rates, it’s important to have a plan associated with any of these changes to realize gains and minimize risk. One option, if longer duration bond ETFs are being used, is to use stop orders to minimize the downside potential should rates head back up.
Longer duration ETFs, mutual funds or individual bonds could trigger capital gains when sold after a significant interest rate decline. Planning should take this into account. If there is latitude in a client’s accounts, some consideration should be given as to where to hold these assets in order to minimize the tax hit from these gains. This could also be a factor in portfolio rebalancing over the next couple of years.
The current environment looks very favorable for bonds. Your guidance can help clients benefit from the current situation while not straying from their long-term investment strategy.
FAQs
As inflation finally seems to be coming under control, and growth is slowing as the global economy feels the full impact of higher interest rates, 2024 could be a compelling year for bonds.
What are some key questions to consider before investing in a bond? ›
key takeaways
- Before investing in a bond, know two things about risk: Your own degree of tolerance for it, and the degree inherent in the instrument (via its rating).
- Consider a bond's maturity date, and whether the issuer can call it back in before it matures.
- Is the bond's interest rate a fixed or a floating one?
Falling interest rates and earnings growth could be a bullish combination for stocks. However, some analysts are concerned about bloated valuations in the technology sector, and the 2024 U.S. presidential election could create some major volatility in the market.
Should I be investing in bonds right now? ›
Answer: Now may be the perfect time to invest in bonds. Yields are at levels you could only dream of 15 years ago, so you'd be locking in substantial, regular income. And, of course, bonds act as a diversifier to your stock portfolio.
What bonds to buy for 2024? ›
Our picks at a glance
| Fund | Yield | Minimum investment |
|---|
| American Funds American High-Income Trust Class A (AHITX) | 6.8% | $250 |
| American Century High Income Fund Investor Class (AHIVX) | 6.9% | $2,500 |
| Fidelity Capital & Income Fund (fa*gIX) | 6.1% | $0 |
| BrandywineGLOBAL – High Yield Fund Class A (BGHAX) | 6.8% | $1,000 |
5 more rowsThe composite rate for I bonds issued from May 2024 through October 2024 is 4.28%.
What is the biggest risk in bond investing? ›
The biggest risk for bonds is typically considered to be interest rate risk, also known as market risk or price risk. Interest rate risk refers to the potential for the value of a bond to fluctuate in response to changes in prevailing interest rates in the market.
What are the three major risks when investing in bonds? ›
- Credit Risk — The risk that a bond's issuer will go into default before a bond reaches maturity.
- Market Risk — The risk that a bond's value will fluctuate with changing market conditions.
- Interest Rate Risk — The risk that a bond's price will fall with rising interest rates.
Holding bond funds for shorter periods than that opens you to the risk of further, short-term gyrations in your fund's value, without sufficient time for recovery. And if you buy longer-term individual bonds and have to sell them, you risk the kinds of losses that investors have been experiencing lately.
What is the biggest risk facing investors during 2024? ›
Risk.net asked more than 60 buy-siders to describe and rank the top investment risks they will face over the coming 12 months. Newly listed in the ranking are a credit crunch, government debt strains, commercial real estate woes, the rise of AI, regulatory overreach and private equity valuations.
The 10 best long-term investments
- Bond funds.
- Dividend stocks.
- Value stocks.
- Target-date funds.
- Real estate.
- Small-cap stocks.
- Robo-advisor portfolio.
- Roth IRA.
With stock indexes at all-time highs, it seems we are in the midst of a new bull market. While much of the market's recent gains have come from a handful of stocks, the rally has begun to broaden in recent months. Expectations of an earnings rebound in 2024 suggest earnings could continue to drive the market higher.
Will bonds outperform stocks in 2024? ›
Vanguard's active fixed income team believes emerging markets (EM) bonds could outperform much of the rest of the fixed income market in 2024 because of the likelihood of declining global interest rates, the current yield premium over U.S. investment-grade bonds, and a longer duration profile than U.S. high yield.
Why are bonds losing money right now? ›
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.
Should you invest in bonds when interest rates are high? ›
The answer is both yes and no, depending on why you're investing. Investing in bonds when interest rates have peaked can yield higher returns. However, rising interest rates reward bond investors who reinvest their principal over time. It's hard to time the bond market.
What are the stock market predictions for 2024? ›
The Big Money bulls forecast that the Dow Jones Industrial Average will end 2024 at about 41,231, 9% higher than current levels. Market optimists had a mean forecast of 5461 for the S&P 500 and 17,143 for the Nasdaq Composite —up 9% and 10%, respectively, from where the indexes were trading on May 1.
What is the financial market outlook for 2024? ›
We expect monetary policy to become increasingly restrictive in real terms in 2024 as inflation falls and offsetting forces wane. The economy will experience a mild downturn as a result. This is necessary to finish the job of returning inflation to target.
Is there a high yield outlook for 2024? ›
High yield spreads have tightened considerably over the past several quarters. As of March 31, 2024, the BofA ICE US High Yield Index's (the “Index”) spread-to-worst was 332bps, significantly lower than the 20-year median of 454bps and at the low end of the post-GFC* general “non-panic range” of 350-550 bps.
What is the credit market outlook for 2024? ›
In 2024 we remain positive on the credit market, anticipating strong total returns and continued demand from yield and duration buyers. Investors are looking to add high-quality duration and to move away from short-maturity investment solutions, made less attractive by major central banks' expected interest rate cuts.
