Why do higher yields make bonds a better investment now?

Why do higher yields make bonds a better investment now?

You don’t have to be a financial wizard to get a secure return of more than 7 percent on your money over the coming decades. All you had to do was buy a 30-year US Treasury bond in the last nine months 1994,

And if you were particularly lucky with your timing and you bought that bond early November 1994So you could have got more than 8 percent interest annually.

Treasuries were elsewhere in the investment-grade bond market. Tax free municipal bonds were paying more than 6 percent, and corporate bond rates were even higher.

Gems of that type are no longer available. Although interest rates have increased significantly, I do not believe we are experiencing a 30-year peak with huge bargains, as the lucky bond buyers of 1994 did.

But I see the similarities. After months of terrible losses, investors who bought and held long-term bonds can hope for a reprieve from disappointing returns in the coming years.

Additionally, with short-term Treasury rates above 5 percent, 10-year Treasury bonds are yielding in the 4.9 percent range and investment-grade corporate bonds At above 6 percent, fixed income investments are attractive – certainly compared to the ultralow rates of a few years ago.

This is not entirely good news. Rising rates hurt borrowers, increasing the costs of mortgages, credit cards, car loans and more. As in 1994, the rise in bond yields is linked to a tightening of the Federal Reserve interest rate cycle and concerns about the future of inflation.

Bond losses, then and now, are the result of rising market yields: prices and yields move in opposite directions in terms of fundamental bond mathematics. That’s because with yields hitting their highest levels in more than 15 years, it’s again a great time to step in and buy investment-quality bonds.

Last week’s column covered some of this. Here are more ideas for bond investing, with plenty of caveats.

I’m a buy-and-hold investor, relying primarily on cheap index funds that track the entire stock and bond markets – an approach that assumes you’ll be able to withstand market ups and downs for many years. Can.

But this won’t work for everyone. Many people don’t have a time horizon of a decade or more. They may be retirees who cannot afford market declines. Or they may be withdrawing the money for a set purpose for a set time period, such as a child’s education or a down payment for a home or vehicle.

For these and many other situations, bonds may be suitable – either through funds or individual securities.

The main bond fund I invest in through my 401(k) tracks the US investment-grade bond universe, as defined by the Bloomberg US Aggregate Bond Index. This type of fund is common in workplace retirement plans. It has been almost stable for the last five years, but in the last three years it has lost more than 5 percent on an annual basis. Still, I’m keeping at it.

There is risk involved. If interest rates rise too much, he may suffer additional losses. This is acceptable to me because I am in it for the long term. But you may not want to tolerate a market decline.

So consider safer options.

At current rates, money-market funds are a good option. Tracked returns on the 100 largest money-market funds crane data Average 5.17 percent, up from almost zero in 2020 and just 0.6 percent in June 2022.

Fees matter, especially for fixed income investments, where returns are typically in the single digits. Pawn’has low fees, and one of its money-market funds returns 5.3 percent.

Money-market funds are not insured by the government, but they do hold government securities, especially Treasuries. Finance textbooks describe Treasuries as risk-free assets, although I can’t make that claim with a straight face. The credit rating of the US government is no longer old. Already this year, the government is on the verge of a shutdown or, worse, breaching its debt limit.

Similarly, if you Shop nearbyBank certificates of deposit and high-yield savings accounts can be good options, which are guaranteed to be as safe as U.S. government credit.

Another way is to buy treasures that you hold until they mature. Last week, two-year Treasuries reached their highest yield since 2006: 5.2 percent. Yields could rise further – it could even fall, no predictions here – but that’s already an attractive payout.

Trading Treasuries can be dangerous: You could lose money if interest rates rise. So if you are risk averse, stick with short-term treasuries or low-cost diversified funds short term Bond funds, which typically hold securities with maturities of one to three years.

You can make treasury purchases through a broker – take care of the fees – or without a middleman treasury direct, The site isn’t easy, but it doesn’t charge any fees. There, you can find savings bonds, classic EE bonds, and inflation-adjusted I bonds, as well as a range of inflation-adjusted and nominal Treasuries.

However, read the fine print. I found EE Savings Bonds interesting. While they offer an interest rate of only 2.5 percent, compared with For I bonds, there is a sweetener, 4.3 percent. Hold the EE Bond for 20 years and the government guarantees that your money will double. That’s an effective, unadjusted interest rate of about 3.6 percent, but only if you hold the bond for that long. While I bond yields are high now, they reset every six months.

Then there are standard Treasury securities, ranging from one-month bills to 30-year bonds, which offer higher yields than investors may receive in years.

It may be tempting to buy a 20-year Treasury with a yield above 5.2 percent with the intention of holding it to maturity.

Whether this is a great purchase, or one you might regret in a few years as interest rates have gotten too high, is a question I can’t answer.

But if it’s any consolation, in 1994 people didn’t even know where interest rates were going. Most articles about the bond at the time were overwhelmingly negative. “A Painful Year of High Rates” was the headline of a representative New York Times article.

In 1995, the Fed planned a rare “soft landing” for the economy, reducing inflation and cutting interest rates without causing a recession. Soft landing is the Fed’s goal this time too. But of course, we don’t know whether it will get there or not.

However, it is unavoidably true that for investors, interest rates are much more attractive than they were a few years ago. There may be better opportunities ahead, but now is already a good time to buy.

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