Should I buy bonds or a bond fund?
Key takeaways. Buying individual bonds can provide increased control and transparency, but typically requires a greater commitment of time and financial resources. Investing in bond funds can make it easier to achieve broad diversification with a lower dollar commitment, but offers less control.
There's no one right answer—bonds or bond funds—for every investor. The decision often comes down to the amount you have to invest, the preference for a professional manager, and the need for a predictable value at maturity.
There are pros and cons to both options. For most investors bond funds will be the best choice. They be slightly more expensive after including expense ratios, but diversification is always important.
The disadvantages of bond funds include higher management fees, the uncertainty created with tax bills, and exposure to interest rate changes.
Short-term bond yields are high currently, but with the Federal Reserve poised to cut interest rates investors may want to consider longer-term bonds or bond funds. High-quality bond investments remain attractive.
The main difference is that an individual bond has a definite maturity date and a fund does not. If you hold a bond to maturity, on that date it will be redeemed at par, regardless of the level of interest rates prevailing on the bond's maturity date.
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.
Holding bonds vs. trading bonds
However, you can also buy and sell bonds on the secondary market. After bonds are initially issued, their worth will fluctuate like a stock's would. If you're holding the bond to maturity, the fluctuations won't matter—your interest payments and face value won't change.
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.
Key Takeaways. 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.
Do bond funds lose value?
Interest rate changes are the primary culprit when bond exchange-traded funds (ETFs) lose value. As interest rates rise, the prices of existing bonds fall, which impacts the value of the ETFs holding these assets.
Treasuries are generally considered"risk-free" since the federal government guarantees them and has never (yet) defaulted. These government bonds are often best for investors seeking a safe haven for their money, particularly during volatile market periods. They offer high liquidity due to an active secondary market.
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..
In the short run, rising interest rates may negatively affect the value of a bond portfolio. However, over the long run, rising interest rates can actually increase a bond portfolio's overall return. This is because money from maturing bonds can be reinvested into new bonds with higher yields.
Bond prices and interest rates move in opposite directions, so when interest rates fall, the value of fixed income investments rises, and when interest rates go up, bond prices fall in value.
ETF | Expense ratio | Yield to maturity |
---|---|---|
Vanguard Total World Bond ETF (BNDW) | 0.05% | 4.9% |
Vanguard Core-Plus Bond ETF (VPLS) | 0.20% | 5.3% |
DoubleLine Commercial Real Estate ETF (DCRE) | 0.39% | 6.2% |
Global X 1-3 Month T-Bill ETF (CLIP) | 0.07% | 5.5% |
Stocks offer ownership and dividends, volatile short-term but driven by long-term earnings growth. Bonds provide stable income, crucial for wealth protection, especially as financial goals approach, balancing diversified portfolios.
Traditionally, the answer has been that bonds provide diversification and income. They zig when stocks zag, providing income for spending needs. In finance terms, bonds have “low correlation” levels to stocks, and adding them to a portfolio would help to reduce the overall portfolio risk.
Bonds tend to rise and fall less dramatically than stocks, which means their prices may fluctuate less. Certain bonds can provide a level of income stability. Some bonds, such as U.S. Treasuries, can provide both stability and liquidity.
A fundamental principle of bond investing is that market interest rates and bond prices generally move in opposite directions. When market interest rates rise, prices of fixed-rate bonds fall. this phenomenon is known as interest rate risk.
Do bonds do well in a recession?
In a recession, investors often turn to bonds, particularly government bonds, as safer investments. The shift from stocks to bonds can increase bond prices, reduce portfolio volatility, and provide a predictable income. However, drawbacks include lower yield potential, default risks, and interest rate risks.
Even if the stock market crashes, you aren't likely to see your bond investments take large hits. However, businesses that have been hard hit by the crash may have a difficult time repaying their bonds.
One says that the percentage of stocks in your portfolio should equal 100 minus your age. So, if you're 30, such a portfolio would contain 70% stocks and 30% bonds (or other safe investments). If you're 60, it might be 40% stocks and 60% bonds.
The valuations of small-capitalization stocks in particular seem to already price in a recession. 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.
- Bond funds. ...
- Municipal bonds. ...
- High-yield bonds. ...
- Money market fund. ...
- Preferred stock. ...
- Corporate bonds. ...
- Certificates of deposit. ...
- Treasury securities.
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