Is It Wise to Invest in Bonds Now?

We have been living in an era of low interest rates for so long, that many investors – especially those that are retired or on the cusp of retiring – are looking for higher-yielding investments. This “quest for yield” in a low-interest rate environment is causing yield-thirsty investors to take a fresh look at U.S Bonds and Treasuries.

Time to Bond

Bonds, especially if they are Sovereign U.S backed or issued by solidly-performing Blue Chip companies, are indeed low-risk places to look for yield. However, Bond investors must realize that, because they are considered low risk, Bonds (and other fixed income vehicles) offer commensurately lower returns. The thesis is:

Because they are a much safer bet than, say, common equities, they pay you less in terms of returns. In effect, investors are accepting lower returns in lieu of lower volatility – than you would otherwise experience by investing in stocks.

But here’s the conundrum:

As interest rates start to rise, the price of existing treasury instruments and bonds start coming under pressure. That’s because investors look to sell of their existing (lower yielding) holdings, in the hope of buying higher-yielding (newer) issues. And that’s exactly what’s been happening recently.

US10Y_chart
https://www.cnbc.com/quotes/?symbol=US10Y

As the U.S. Federal Reserve Bank (Fed) looks set to raise its benchmark interest rate several times this year, yields on 10-Year Treasury Notes have started to creep up – to their highest since April 2014. While a falling Greenback has certainly helped yields climb, other factors such as a bubbling economy and the possibility of rising inflation have also played their part. To anyone building a diversified portfolio containing fixed income investments, the question now is: Where can one find decent yields, and are they safe?

Picks to Consider

Here are two ways that you can invest in bonds, while enjoying relatively reasonable yields, and still take on less risk than some volatile stocks (like REITS and Utilities) or similarly exposed ETFs:

1) iShares Barclays Aggregate Bond Fund ETF (NYSEARCA:AGG)

AGG offers a great way for investors to get broad-based exposure to an index of fixed-income vehicles. It includes corporate bonds, U.S. Treasury bonds, commercial mortgage-backed securities, mortgage-backed pass-through securities and asset-backed securities.

https://www.ishares.com/us/products/239458/ishares-core-total-us-bond-market-etf#chartDialog

As should any index-based product, AGG has faithfully tracked its underlying index, the Bloomberg Barclays US Aggregate Bond Index, yielding a reasonable 10-year total return of 3.90% (versus 4.01% for its benchmark). For cost-conscious investors, AGG is competitively priced with an Net Expense Ratio of 0.05%.

2)  Vanguard Intermediate Tm Cpte Bd ETF (NASDAQ:VCIT)

If you have a slightly higher tolerance for risk (compared to AGG), then you may want to take a close look at VCIT. Designed to track the Bloomberg Barclays U.S. 5-10 Year Corporate Bond Index, VCIT invests in a range of investment grade U.S corporate bonds in the 5 to 10-year time horizon.

https://personal.vanguard.com/us/funds/snapshot?FundId=3146&FundIntExt=INT&funds_disable_redirect=true#tab=1

The reason that VCIT is considered slightly more risky than AGG, is that it is more focused on Corporate debt, compared to the safer Government-debt leaning AGG.

Over a 5-year period (since its inception), VCIT has lagged only slightly behind its benchmark (yielding a 3.37% return versus 3.49% for its benchmark) but has handily beat the Bloomberg Barclays US Aggregate Bond Index over that timeframe. With an Expense Ratio of 0.07%, the VCIT offers a good price/return value proposition.

Points to Remember

The two traditional ways to add higher yields through bond investments are:

a) Going long: The longer you go on your bonds (e.g. 30 years instead of 5), the higher yields you’ll enjoy. That’s because there’s much more uncertainty over a 30-year period (compared to 5 years), and therefore bond issuers must compensate you for that uncertainty

b) Risking it all: You can also find higher yield if you invest in bonds (either Sovereign debt or Corporate) of issuers with a less than perfect credit profile. Since these are riskier investments, you will receive higher yields for taking that risk

In uncertain times like we are faced today, the best advice that any portfolio manager will give clients looking to invest in bonds is: Stay short. Look for quality. Review your holdings frequently to make informed renewal decisions upon maturity.

The Author does not own any of the stocks or bonds discussed in the article.