Seven years after the end of the worst financial crisis since the Great Depression, the U.S. economy continues to lead the developed world. Gross domestic product in the U.S. has been rising only about 2% annually (compared with a more normal 3%), but the economies of most other major nations are at or just above stall speed.
Will we ever get back to normal global growth? Probably, given time, but a return to the good old days is still a ways in the future.
Meantime, efforts by central bankers to light a fire under the global economy have pushed down bond yields to ridiculously low levels. Until growth picks up, those yields should stay artificially low. Citing concerns over sluggish employment growth, the Federal Reserve once again opted to leave rates unchanged at its just-concluded June meeting.
Because interest rates are so low, investing in most kinds of bonds is risky. If yields increase (and there’s a lot more room for rates to rise than there is for them to decline), bond prices will fall, so fixed-income investors must be vigilant.
Take the benchmark 10-year Treasury bond. As of June 14, it yielded a puny 1.61%. If consumer prices rise at the historical annual rate of 3%, a 10-year Treasury is a guaranteed loser even if the bond’s price remains unchanged. Heck, even at 2% inflation, you’ll be in the hole with a 10-year Treasury because the bond’s interest will be less than the rise in consumer prices.
The best argument for owning U.S. Treasuries is that they pay more today than government bonds issued by many other developed countries. Many overseas bonds sport negative yields -- a phenomenon I can’t begin to understand. In effect, you buy a government bond knowing that you will get back less when the IOU matures than you put in. Makes me want to buy stock in a company that makes safe-deposit boxes.
The advent of negative yields has prompted investors to lock up their cash in super-long-term bonds that pay meager yields. Spain—get this—recently issued 50-year bonds with a 3.45% coupon. France also issued 50-year bonds. Belgium and Ireland each sold 100 million euros of 100-year bonds in private deals.
I predict that one day we will look back on long-term bonds with tiny or negative yields, such as the 10-year Treasury, in much the same way we now view the insanely high price-earnings ratios of tech stocks in the late 1990s.
When yields inevitably do head north, those holding the bonds will suffer huge losses. Just a one-percentage-point rise in the yield on the 10-year Treasury would cause its price to fall by 9%. A two-percentage-point increase would trigger a 17% plunge. Depending upon their current yields, a one-percentage-point rise in 50-year and 100-year bonds would bring a collapse of 25% to 45%.
The Case for Owning Bonds Today
Why own bonds at all? Because stashing all your money in stocks can be too risky. Bonds provide ballast for your portfolio, and investment-grade bonds often rise, or at least generate positive total returns, during periods of falling stock prices.
Bonds issued by shaky companies (aptly called junk bonds) currently offer the most attractive yields: 7%, on average. But high-yield bonds come with substantial risk that the issuer might not be able to pay you back and often perform poorly when stocks are tanking.
With all that in mind, here are my favorite bond mutual funds and exchange-traded-fund picks for the current market, listed from the most conservative to the riskiest. Note that I’m not including past returns for any of the funds because they would tell you little about how the funds will likely do in the future.
You’ll never grow rich owning Vanguard Short-Term Corporate Bond ETF (symbol VCSH (opens in new tab)), but you won’t go broke, either. I especially love two numbers about this fund: its annual expense ratio of just 0.10% and its average duration of 2.8 years (duration is a measure of interest-rate sensitivity; a duration of 2.8 years suggests that the fund’s price would drop by 2.8% if interest rates rose by one percentage point). The exchange-traded fund invests in short-term, high-quality corporate and government bonds. It yields just 1.9%, but the modest payout is a fair trade-off for the low risk.
For money held in taxable accounts, I favor Vanguard Limited-Term Tax Exempt (VMLTX (opens in new tab)), which charges 0.20% a year and yields a paltry 0.9% (equivalent to a taxable 1.6% for an investor in the top, 43.4% bracket). But the average duration is only 2.5 years. If you can meet the $50,000 minimum, you can qualify for the fund’s Admiral share class (VMLUX (opens in new tab)), which charges just 0.12% and yields 1.0% (a taxable-equivalent yield of 1.8% for a top-bracket investor). If you find it beneficial to invest in a single-state muni fund, which delivers interest that is free of federal and state income taxes, make sure it has a relatively modest duration.
Jeffrey Gundlach, comanager of DoubleLine Total Return Bond N (DLTNX (opens in new tab)), has been a good prognosticator of the future course of interest rates. Over the past six months, he has trimmed his fund’s average duration from 3.5 years to 2.9 years, suggesting that he thinks rates will rise a bit. Total Return, which sports a relatively generous 3.2% yield, holds a mix of government mortgages and much riskier privately backed mortgages. About 20% of its assets earn junk ratings. (The fund is a member of the Kiplinger 25.)As the name suggests, Metropolitan West Unconstrained Bond (MWCRX (opens in new tab)) has a lot of flexibility. Among other things, the managers can sell bonds short (that is, bet on their prices to fall and yields to rise). At last report, the fund’s average duration was just 1.4 years. Some 85% of the fund’s assets are in corporate bonds, non-government-backed mortgages and other securitized debt. All told, about one-fourth of the fund’s assets was in junk-rated securities. The fund yields 2.5%. Its four managers have a long and superior track record running Metropolitan West Total Return (MWTRX (opens in new tab)), a more-traditional, middle-of-the-road bond fund that is a member of the Kiplinger 25.
Loomis Sayles Bond (LSBRX (opens in new tab)) fishes in treacherous waters. The fund, which yields 3.9%, has about 30% of its assets in bonds with junk ratings and another 10% in unrated bonds, as well as 8% in common stocks. It also invests a sizable chunk in foreign bonds. Says comanager Elaine Stokes: “There’s so little yield in the world that we don’t think it pays to be in bonds with high credit ratings.”
Steve Goldberg (opens in new tab) is an investment adviser in the Washington, D.C., area.
Can You Build a Retirement Income Plan With Both Risk and Reliability?
Two strategies for making retirement savings last — probability-based income planning and guaranteed income planning — can help ensure you have what you need in your golden years, but which is right for you?
By Scott M. Dougan, RFC, Investment Adviser • Published
5 Financial Wellness Tips to Help Weather the Winter
You can regain some control over today’s money pressures by exploring your employer's financial support options and benefits, making plans to save and taking other simple actions.
By Aaron Harding, CFP® • Published
I-Bond Rate Is 6.89% for Next Six Months
Investing for Income If you missed out on the opportunity to buy I-bonds at their recent high, don’t despair. The new rate is still good, and even has a little sweetener built in.
By David Muhlbaum • Last updated
The 15 Best Stocks to Buy for the Rest of 2022
stocks to buy The lesson of the past two years: Be ready for anything. Our 15 best stocks to buy for the rest of 2022 reflect several possible outcomes for the final quarter of this tumultuous year.
By Charles Lewis Sizemore, CFA • Last updated
4 Steps for Managing Income Withdrawals in Retirement
Investing for Income How Roth IRA conversions can help you minimize your taxes in retirement, extending the life of your savings.
By Kyle Hammerschmidt, Investment Adviser • Published
3 Bond Funds to Build on a Summer Rally
bonds The market expects consistently lower inflation to arrive sooner rather than later. That's great news for these three bond funds.
By Jeffrey R. Kosnett • Published
Hedge Funds' 21 Top Blue-Chip Stocks to Buy Now
Investing for Income What is the reputed smart money up to lately? We explore the 21 most popular blue-chip stocks among the hedge fund crowd.
By Dan Burrows • Published
10 Dividend Growth Stocks Delivering Impressive Increases
dividend stocks Adding dividend growth stocks to your portfolio can provide both income and capital appreciation over the long haul. That makes these 10 picks worth a closer look.
By Will Ashworth • Published
Taxable or Tax-Deferred Account: How to Pick
Investing for Income Use our guide to decide which assets belong in a taxable account and which go into a tax-advantaged account.
By Nellie S. Huang • Published
10 Bond Funds to Buy Now
Investing for Income Bond funds have seen sizable losses so far this year, but yields are now rising to attractive levels for income-starved investors.
By Adam Shell • Published