High bond yields are making the fixed-income corner of investors’ portfolios exciting — but there’s a right way and a wrong way to seek income. The bond attracted investor attention in 2022 as the Federal Reserve began a rate-hike campaign to reduce inflation. Bond yields and prices move inversely to each other, so as rates rose, prices fell — and did so at an inopportune time, as stocks were also suffering. Consider that the iShares Core Growth Allocation ETF (AOR), which is allocated to 60% stocks and 40% bonds, fell 17% in 2022. But for investors seeking reliable income from interest payments at low cost, it was a good time to break some bonds. These days, you don’t even need to chase junk bonds for attractive returns. Consider that the six-month Treasury note is yielding 4.88%, while the three-month T-bill touts a rate of 4.69%. US1M US3M, US6M 1Y line T-bills look attractive as rates remain elevated. “Short-dated yields are now over 4%, which is quite attractive,” said Hans Olsen, chief investment officer at Fiduciary Trust. “With inflation coming down, there is a real possibility that people will make real returns on their cash balances, which is a remarkable situation.” Here’s how to play those high yields without getting burned. Looking for the short term Last year, investors seeking relative safety flocked to long-term government bond funds. Those funds generated $46.6 billion in net inflows, the most among all fixed-income categories, according to data from Morningstar. Given the inverted yield curve — short-dated bonds have higher yields than their long-dated counterparts — financial advisors are looking more closely at short-term bonds. Duration, a measure of interest rate sensitivity, is also a focal point when selecting a bond. Issues with longer maturity have longer duration. Thus, they have higher interest rate risk and greater price volatility. The US2Y US10Y 1Y line yield curve inversion has made the shorter dated issues more attractive than their longer term counterparts. “People’s risk appetite has plummeted since last year, and you need a year like last year to remind people,” said Thomas Balcom, certified financial planner and founder of 1650 Wealth Management. He likes short-term Treasury bond funds and ETFs. “By rebalancing in these products, you can earn some returns this year with virtually no risk,” Balcom said. “It also improves performance and risk parameters.” This also raises the question of whether an individual bond or bond fund is the best fit for your circumstances. Consider that individual bonds make interest payments twice a year, but bond funds typically make monthly distributions that can be reinvested back into the fund or paid out as cash to the investor. Bond funds offer easy diversification and may be suitable for investors who would not be practical. However, the market value of these funds fluctuates, whereas investors with individual bonds know exactly what they will get if they hold them to maturity. Yield Mitigation Strategies The result of holding different bonds is that you can use a variety of strategies to manage interest rate risk. Laddering allows you to stack bonds of different maturities. As your near-dated bond matures, you can redistribute the proceeds into a longer-dated bond. The advantage is that you are mitigating the effect of interest rate fluctuations. If you’re looking for income that’s free of federal taxes — and state income taxes if the issuer is in your home state — another laddering technique would be using municipal bonds. Ashton Lawrence, CFP and partner at Goldfinch Wealth Management, said, “For the muni bond ladder, we are willing to take a slightly higher duration risk, but if you can find a high-quality municipal bond trading at a discount, it is worth it. is better.” Another way to reduce interest rate risk is to use a barbell: You have equal amounts of short- and long-term issues. Once those near-dated bonds mature, you can take advantage of the rising yield by buying another, shorter-dated bond. Quality is everything. Moody’s Investors Service, Standard & Poor’s and Fitch provide ratings that reflect the credit quality of bond issuers. Investment grade corporate bonds rank from AAA to BBB, with the top rated issues having the lowest default risk. According to Bank of America, approximately 90% of investment grade corporate bonds are rated either A or BBB. High-yield bonds, also known as junk bonds, are issued by companies with low credit ratings. Investors are compensated for the risk, so bonds offer better yields. Consider that the SPDR Portfolio Short Term Treasury ETF (SPTS) has a 30-day SEC yield of 4.23%, the SPDR Bloomberg High Yield Bond ETF (JNK) has a 30-day SEC yield of 7.57%. But while the annual default rate on investment grade bonds has been less than 1%, the annual default rate on high-yield bonds ranges from 1.4% to 15.7%, according to data from Moody’s Investors Service. High-yield bonds also tend to be more correlated with stocks than other bonds, meaning that adding them to your portfolio increases your risk. “Understand the credit and interest rate risk, as well as the potential equity correlation investors take on when they jump to those higher yields,” said Michael Aron, chief investment strategist for the US SPDR business at State Street Global Advisors. “You don’t have to be very exposed to credit risk and interest rate risk to get a healthy yield in today’s environment.” — CNBC’s Michael Bloom contributed to this story.
Bond yields are up, but be smart about how you invest. where to start here
