The Bonds that Tie – An Exciting Look at Fixed Income

What’s your opinion of bonds and the direction yields are headed? Buy, sell, or maintain in your portfolio – that’s the question in today’s investing environment. Read on for the popular opinions and what to consider before you invest.

Popular Opinion #1: Tariffs are coming, and inflation will be rising. Interest rates will have to increase, and you don’t want to own bonds!

Popular Opinion #2: The economy is softening. With demand for goods likely to be lower, inflation will ease. Interest rates will need to move lower, and you do want to own bonds!

Popular Opinion #3: Who cares, I want to talk about crypto!

Between #1 and #2, which opinion is right? A case can be made for either or neither. What should we do with our fixed-income portfolio during these times? Regardless of how events unfold, you may be surprised to learn that opportunities abound and recent yields are providing potential returns that had been absent for many years.

Still Reading? Keep Going…

If you’ve made it this far into a discussion about bonds, keep going. Bonds are often thought to be boring and academic, especially when compared with the exciting world of stocks. Considering that fixed income often makes up between 30% and 50% of an investor’s portfolio, the investments that fall under the fixed income wrapper, such as bonds, CDs, and money markets, get very little attention. They deserve more, and today we’ll give them more.

If you’re worried about rising interest rates, you can still own the following bonds, but consider holding them in shorter-term positions. The shorter the maturity (or duration) of the bond, the less sensitive they are to rising interest rates. I’m leaving out the math so that you don’t fall asleep!

• US Treasuries – a 10-year Treasury was recently yielding 4.25%. Short-term rates are similar, and 30-year rates are closer to 5%. If you want US government-backed security with a higher yield, then agency mortgages can give you 5% yields. Mortgages do have pre-payment potential. As you know, mortgage borrowers enjoy refinancing, but the opposite is true for mortgage investors.
  
  
• Municipal Bonds – they took a hit earlier this year but have since been slowly climbing. You can invest in tax-free intermediate-term bonds that yield 3.7%. If you are in a higher income tax bracket, the tax-adjusted yield could be more than 5%, which is well above the 4.25% yield of the 10-year Treasury.
  
  
• CDs – if you like the security of FDIC-insurance, you should be able to lock in approximately 4%.

With the above securities, you will lock in the yields for a specific time. The following securities have rates that will adjust and can move higher or lower over time.

• I-Bonds – if you buy an I-Bond today, you will lock in a yield of 4% for the next six months. Going forward, the yield will adjust every six months based on inflation rates. The bonus with buying an I-Bond today is that it pays a fixed rate of 1.1% plus an inflation rate for as long as you own the bond. Even more exciting is that you won’t owe income taxes on the income until you redeem the bond.
  
  
• Money Market Funds – money market rates fluctuate daily, with some currently yielding close to 4%. These liquid investments offer attractive yields, but these yields will decline when the Federal Reserve lowers rates. Since this may not happen for several months, you can enjoy the 4%+ yield for the time being.
  
  
• Private debt – borrowers can bypass public markets and access debt through private sources of capital. As investors providing capital to these borrowers, we can access investments that yield 10% or more.

With these higher yields come different risks and less liquidity. Still, private debt can be an attractive investment, provided you can leave the money invested for a while. If you ever want out, private debt can limit redemptions (sales), which can delay your access to the cash.

A big risk with private debt is that the investment can be highly leveraged. This amplifies the return both positively and negatively. Sometimes excitement can be good, and sometimes it can be detrimental.

Summary

The above yields represent the potential returns for higher-quality investments within each type. You can get even higher yields if you want to take on higher credit risk. For example, with corporate bonds, it is easy to find yields in the 5-7 percent range. Preferred stocks can be 6-7%.

With today’s yields being much higher than the close to 0% yields that prevailed for many years, fixed income investments can offer attractive returns for that part of your portfolio that serves as a ballast.

To understand the implications of any investment decision, professional advice is recommended.

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