“Bye Bye and Buy Bonds” was a sign often used by Bob Hope during World War II. It was a promotion to buy U.S. Savings bonds to help fund the war effort. Catchy phrase, I think.
As we enter the era of a new administration, which has brought uncertainty and volatility to the markets, we ask ourselves, is now a good time to buy bonds? The short answer is, “yes, and.”
Investing in fixed income is commonly used by investors for portfolio diversification, to reduce volatility, and to provide income. For many years after the 2008 financial crisis, rates, driven by the Fed to help in resuscitating the economy, were kept low. This presented another opportunity: capital appreciation. As rates came down, bond prices went up and an investor could make a profitable trade on the principal of their investment.
Historically, this capital gain, total return objective was counter intuitive for bond buyers but became popular, particularly for bond fund buyers, during the declining interest rate environment. Individual bonds vs bond funds – why does that matter, you ask. Well, you see, individual bonds offer one key feature to the investor that bond funds do not. A set maturity. This maturity date indicates the return of face value of the bond on a set date to the investor. We saw the importance of this as recently as 2022 – as the Fed increased rates to combat inflation, bond prices were pressured down. Bond fund holders, who own a piece of a basket of bonds, were left with a great deal of uncertainty, but investors who held individual bonds were in a much better position as they controlled their duration and maturity. These investors sat back and were less concerned about the intermediate price volatility. They knew, regardless of rates in the marketplace, that if they held their bond until maturity, they “got their money back.” That peace of mind is invaluable to a bond investor.
While we are waiting to “get our money back” at maturity, what can we, as bond buyers, get for our lending efforts? The treasury yield curve, meaning the yield of various terms of maturities of treasury securities from short to long, is not perfect, but it is not inverted, as it was just a few months back. That is a good thing. Short term yields are lower than long term yields. This is much healthier for the economy and investors alike. On the short end, we are currently seeing yields of 4.27% of a 1 year treasury, 4.52% for a 10 year treasury, and 4.76% for 30 year treasury. While this is an increasing yield curve, it is a tight spread, indicating uncertain economic conditions. Yield spreads change on an ongoing basis and vary between types of bonds, but they are worth keeping in mind when shopping for your bonds. In more normal times, we would hope to see something closer to 6.5% on a 30 year treasury if a ten year were quoted at 4.5%. The current 4.76% for the 30 year is a very tight spread making it less attractive to investors. When deciding between treasuries, corporates, and municipal bonds, one must understand their features. Treasuries offer the highest credit quality and marketability. Interest income is Federally taxable and state tax exempt. Corporates vary in credit quality by issuer, type, and call features. They are fully taxable – federal and state. Municipal bonds are federally tax exempt and often exempt from state taxes – depending on the investors state of residence. Quality and safety vary depending upon the funding for debt service. Like corporates, municipal securities often have call features. Treasuries and corporates are issued in $1K denominations, municipals in $5K denominations. We look to stay with investment grade bonds for our fixed income allocations and set maximum allocation exposure by maturity, issuer, and municipal location in building bond ladders. As is true in equities, diversification is important in an investors’ fixed income portfolio. Bonds are no longer buy and forget investments. They must be monitored for underlying changes. We currently see opportunities in the spreads between municipals and treasuries which favor municipals.
Now let’s circle back to the question with which we started. Is now a good time to buy bonds? The simple answer to that is, “Yes.” The more complicated answer is, “Yes, and be sure to know what you are doing.” 1) Watch Washington in addition to watching the Fed. Economic uncertainty and having stable trading partners affect the bond market in addition to the stock market. 2) Build a bond ladder if you have the financial wherewithal to obtain sufficient diversification. 3) Stay short to intermediate in duration and maturity. Until we are rewarded in yield for buying longer maturities, there is no reason to rush to lengthen a bond ladder. 4) Look to your equity allocation for capital gains, not your bond allocation. Bonds are intended to be blissfully boring and provide stability to your portfolio, if you sell and receive a total return above the original yield to maturity, consider it a bonus, not an objective. 5) Know your risk tolerance. Choosing an allocation of bonds is most dependent upon your tolerance for risk not your age. Many “older” investors, who have been bond buyers in the past, have greater wealth and a greater tolerance for risk. Given the optimism following the past two years of solid gains in the equity market and the long term trend of double digit equity returns, we are seeing a trend in increased bond holdings regardless of age.
Bonds have their place in investor portfolios of course with diversification in equities as well. If you don’t have the time or knowledge to build this out yourself, give us a call. Investing is what we do.
All for now.
Bye Bye and Buy Some Bonds.