While the markets reflect worry about a possible recession, Vanguard says that bonds could offer long-term investors opportunities to make money with yields above inflation. Furthermore, the financial firm believes that investors could also use bonds as a “stable hedge to equities after spending most of the year correlated with risk assets.” Let’s break down the benefits and risks of investing in bonds.
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Why Vanguard Thinks You Can Make Money With Bonds
In an overview of the first half of 2022, Vanguard says that markets have had to rethink how high the Federal Reserve will be able to hike rates before pulling back. This has created an opportunity for investors to make money with bonds.
“Long-term investors should cheer — yields above the inflation expected over the next five years or longer exist in the Treasury market for the first time since a brief spike during the initial COVID panic of March 2020. For those looking for tangible income, that exists now, too,” the financial firm said in its overview.
For reference, the Federal Reserve raised rates on May 5, June 15 and July 27, most recently raising rates by 75 basis points. And central banks around the world have similarly increased their rates as well. “Markets now see the Fed hiking faster, but pulling back more quickly,” Vanguard says.
After spending most of the first half of 2022 correlated with risk assets, Vanguard says, bonds have also started to behave as a stable hedge against equities. “Signs of a weaker economy ahead are likely to validate the role of bonds as a portfolio diversifier.”
Investors should note that bonds have traditionally been seen as safer investments than stocks are. But with lower returns, most bonds are not necessarily used as a hedge to beat inflation. One notable exception is Treasury Inflation-Protected Securities (TIPS), which allow investment principal to increase alongside the Consumer Price Index (CPI).
Understanding How Bonds Work
Bonds are fixed-income investments, which means that investors know how much their return will be before buying them. When you buy a bond, you are lending money to the government or a company. The organization will pay you back in interest over time.
As a bond investor, you will be able to see its price, maturity date and coupon rate. The coupon rate is the annual rate at which the bond will repay you as the holder. This rate is based on the face value of the bond, which is the amount that the issuer will pay once it hits maturity. And because it is a fixed payment, it will remain the same for the life of the bond.
Bonds are a common staple for investors who look to diversify their portfolios outside of stocks. They are often regarded as “safer” investments, and investors nearing retirement are often counseled to increase their bond holdings. While you likely won’t get a double-digit return on bonds like you could with stocks, bonds typically offer more consistency and predictability.
Where Fixed-Income Opportunities Are Today
All bonds are not created equally. They offer different objectives and levels of risk and rewards. Below are three common types of bonds that can put money in your portfolio:
High-yield bonds. High-yield bonds aim to generate income and consistent returns for investors. These bonds also come with higher risk. According to Bloomberg’s Index data, high-yield bonds showed positive returns in July, with a gain of 5.9%, which is the biggest in a decade.
Treasury bonds. These are government debt securities that are issued by the U.S. federal government. When you buy this bond from the government, you’re expecting to get interest back at the end of each six-month period. For most of the first half of 2022, Treasury bond real yields were down across a wide range of maturities. However, the U.S. Department of Treasury says that this asset had an upswing with five-year, seven-year, 10-year, 20-year and 30-year yields ranging from 0.43% to 0.91%.
Municipal bonds. These bonds are associated with local and state government agencies. Municipal bonds offer reliable income without the risk of high-yield bonds. And Vanguard says that this asset yielded 3.21% as of June 30, “which equates to a tax-adjusted yield of 5.42% for investors in the highest federal income tax bracket.”
Bonds could make a noticeable turnaround in 2022. And Vanguard says high-yield bonds, municipal bonds and Treasury bonds could offer long-term investors opportunities to make money.
Tips for Smart Investing
A financial advisor can help you create a balanced portfolio with a blend of bonds and other investment types. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
If you need help finding a balance for your portfolio, SmartAsset’s asset allocation calculator can help you determine what to invest in.
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