Is it better to buy bonds or bond funds?
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.
We suggest investors consider high-quality, intermediate- or long-term bond investments rather than sitting in cash or other short-term bond investments. With the Fed likely to cut rates soon, we don't want investors caught off guard when the yields on short-term investments likely decline as well.
The downside to owning bond funds is: The management fee: Management fees for the more actively traded bond funds can be higher, which may lead to lower returns.
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.
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.
Bond prices have an inverse relationship with interest rates. This means that when interest rates go up, bond prices go down and when interest rates go down, bond prices go up.
The answer is both yes and no, depending on why you're investing. Investing in bonds when interest rates have peaked can yield higher returns. However, rising interest rates reward bond investors who reinvest their principal over time. It's hard to time the bond market.
Bonds are a type of fixed-income investment. You can make money on a bond from interest payments and by selling it for more than you paid. You can lose money on a bond if you sell it for less than you paid or the issuer defaults on their payments.
Bonds are generally considered a less-risky complement to the volatility of stocks in an investment portfolio. U.S. Treasurys, and specifically Treasury bills and Treasury notes, are the benchmark for a nearly risk-free investment if held to maturity.
Inflation Risk
Just as inflation erodes the buying power of money, it can erode the value of a bond's returns. Inflation risk has the greatest effect on fixed bonds, which have a set interest rate from inception.
Do bond funds 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.
Face Value | Purchase Amount | 30-Year Value (Purchased May 1990) |
---|---|---|
$50 Bond | $100 | $207.36 |
$100 Bond | $200 | $414.72 |
$500 Bond | $400 | $1,036.80 |
$1,000 Bond | $800 | $2,073.60 |
If you own shares of a bond ETF, you might have a sinking feeling seeing the market value of your investment dip as interest rates increase. However, it's worth noting that rising interest rates can't last forever, and bond ETF prices are likely to recover once rates go lower.
ETF | Expense ratio | Yield to maturity |
---|---|---|
SPDR Portfolio Corporate Bond ETF (SPBO) | 0.03% | 5.5% |
JPMorgan Ultra-Short Income ETF (JPST) | 0.18% | 5.5% |
iShares 7-10 Year Treasury Bond ETF (IEF) | 0.15% | 4.4% |
iShares 10-20 Year Treasury Bond ETF (TLH) | 0.15% | 4.6% |
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.
- HDFC Corporate Bond Fund.
- Aditya Birla Sun Life Corporate Bond Fund.
- ICICI Prudential Corporate Bond Fund.
- Sundaram Corporate Bond Fund.
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.
Fund | Expense ratio |
---|---|
Vanguard Total Bond Market Index Fund Admiral Shares (ticker: VBTLX) | 0.05% |
Vanguard Total International Bond ETF (BNDX) | 0.07% |
Vanguard Short-Term Treasury ETF (VGSH) | 0.04% |
Vanguard Ultra-Short Bond ETF (VUSB) | 0.10% |
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.
Ticker | Fund | Expense Ratio |
---|---|---|
BLV | Vanguard Long-Term Bond ETF | 0.04% |
ZROZ | PIMCO 25+ Year Zero Coupon US Treasury ETF | 0.15% |
VCIT | Vanguard Intermediate-Term Corporate Bond ETF | 0.04% |
IEF | iShares 7-10 Year Treasury Bond ETF | 0.15% |
What is the difference between a bond and a bond fund?
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.
One of the simplest ways to invest in bonds is by purchasing a mutual fund or ETF that specializes in bonds. Government bonds can be purchased directly through government-sponsored websites without the need for a broker, though they can also be found as part of mutual funds or ETFs.
The main ways to lose money on bonds include price decreases due to interest rate increases, default or bankruptcy of the bond issuer, call risk, reinvestment risk, and inflation risk. Each of these factors can potentially lead to a decrease in the value of your bond investment or a loss of your initial investment.
There are many adages to help you determine how to allocate stocks and bonds in your portfolio. 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).
There are two ways to make money by investing in bonds. The first is to hold those bonds until their maturity date and collect interest payments on them. Bond interest is usually paid twice a year. The second way to profit from bonds is to sell them at a price that's higher than you initially paid.
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