bonds

Best Ways to Invest in Bonds Now

With Donald Trump's election, the yield on U.S. bonds has risen dramatically. That spells opportunity for bond investors.

Interest rates paid to investors and savers have been a joke for years: a few hundredths of a percentage point from money market funds, or a percentage point or two (if you’re lucky) from CDs. Thirty-year Treasuries have yielded less than 3%, and securities such as two-year Italian bonds have actually had negative interest rates (meaning you pay the government for the privilege of lending it money).

Analysts have been predicting that rates were inevitably bound to turn around. Now, after many false starts, it appears they really are—in part because of Donald Trump. With his election, the yield on U.S. bonds—the percentage of your investment you get for holding them—has risen dramatically. That spells opportunity for bond investors who seek relatively high income without taking inordinate risks.

Rates versus yields. Bonds are called fixed-income securities for a reason. With nearly all such debt, you make an immutable deal. The borrower (typically a corporation or government) pays you a flat rate of interest for the life of the bond. For the past 30 years, rates have been going down. The benchmark 10-year Treasury bond—the debt that the U.S. government issues with the promise to pay back principal in 10 years—peaked in 1981 at nearly 16%.

After bouncing up and down for six years, the rate hit a new peak of about 10% in 1987, then started a persistent decline, which rewarded existing bondholders handsomely because they not only collected high amounts of interest but also saw the value of their bonds increase, before their prices eventually started to trend toward face value as their maturity dates approached.

Although it may seem paradoxical, bond prices rise when bond rates decline. Why? Imagine you own a $1,000 bond that is issued by the government with a coupon, or a stated promise to pay interest, of 5%. Now imagine that a few years later, interest rates overall start falling, and new bonds like the one you own are being issued at a rate of just 3%. Your bond, paying 5%, is much more valuable than when you bought it. If you sell it on the open market, you will get considerably more than you paid for it.

Now suppose you buy a bond today that yields 2.5%. If interest rates rise and new bonds start carrying coupons of 5% (roughly the historical average), the 2.5% yield on your bond will look awfully puny. If you sell before the bond matures, you’ll have to take a loss. That’s what’s known as interest rate risk, and all bonds carry it.

So the big question is where rates will go from here. If you think next year’s rates will be a lot higher, you will want to wait before you buy long-term bonds.

The Trump effect. On the day after the election, the yield on the 10-year Treasury jumped from just under 1.9% to nearly 2.1% and kept climbing (which means prices fell). By year-end, the yield was 2.5%—an increase of nearly one-third. Trump wasn’t the only reason for the increase. The 10-year Treasury’s yield actually bottomed, at 1.37%, on July 5.

Rates of nearly all bonds tend to rise when investors are worried about inflation. If you buy a 10-year bond today and the annual inflation rate runs 5% for the next decade, the government will return your principal with dollars that have lost two-fifths of their purchasing power. Naturally, investors demand to be compensated for that loss with higher income along the way.

Consumer inflation has been low since the 2007–09 recession. Investors, however, worry that Trump’s election will bring both higher federal expenditures (from a promised trillion dollars in new infrastructure spending) and lower revenues (from promised tax-rate cuts). That means a bigger deficit, plus probably more economic growth—and, thus, higher inflation. Inflation will also get a boost if Trump erects trade barriers against countries such as China because decreased competition will probably result in higher prices for domestically produced goods.

Actually, both growth and inflation showed signs of picking up before Trump’s election, with the unemployment rate dropping to a nine-year low of 4.6% in November. So in December, the Federal Reserve raised very-short-term rates by one-fourth percentage point. Kiplinger expects two more hikes in 2017).

One way to hedge against interest rate risk is to buy bonds that mature at intervals, a strategy called laddering. Some fund sponsors make laddering easier. Deciding whose bonds to buy is also tricky. Check out my eclectic list of 6 Bond Funds to Boost Your Income.

Most Popular

Your Guide to Roth Conversions
Special Report
Tax Breaks

Your Guide to Roth Conversions

A Kiplinger Special Report
February 25, 2021
The Berkshire Hathaway Portfolio: All 41 Warren Buffett Stocks Ranked
stocks

The Berkshire Hathaway Portfolio: All 41 Warren Buffett Stocks Ranked

The Berkshire Hathaway portfolio is a diverse set of blue chips, and increasingly, lesser-known growth bets. Here's a look at every stock picked by Wa…
November 16, 2021
Resist the Impulse to Buy These 14 Holiday Gifts
shopping

Resist the Impulse to Buy These 14 Holiday Gifts

Don't let those holiday sale promotions persuade you into buying something now that will be much cheaper later.
November 18, 2021

Recommended

How Leveraging Alternative Assets and Modern Portfolio Theory Can Help Investors Improve Returns
investing

How Leveraging Alternative Assets and Modern Portfolio Theory Can Help Investors Improve Returns

To help manage risks and possibly boost returns, everyday investors should think about including alt investments in their portfolios. Here’s how to ap…
December 4, 2021
Investing for Income with Jeffrey Kosnett
investing

Investing for Income with Jeffrey Kosnett

Cold, hard cash working from home! No, this isn’t a scam — it’s an investing strategy built on bonds, REITs, preferred stocks and more.
November 30, 2021
Where to Find Yield in 2022
Kiplinger's Investing Outlook

Where to Find Yield in 2022

I am sold on leveraged closed-end debt funds, junk bonds and floating-rate bank loan funds.
November 29, 2021
When Actively Managed Funds Are Worth It
Becoming an Investor

When Actively Managed Funds Are Worth It

For some investment categories, choosing an actively managed fund makes sense.
November 24, 2021