Now that the dust has settled on the fourth-quarter 2018 market mayhem, it's time for fixed-income investors to review the instant replay. Did your core bond funds hold their ground, or even advance a little, as stocks stumbled? Or did they retreat, leaving you with red ink in every part of your portfolio?
If your answer is the former, you're likely on the right track with your bond holdings. If it's the latter, it's time to rethink your selection of core bond funds and the role that bonds play in your portfolio.
For retirees, bond funds should generally act as ballast, helping you withstand market volatility and giving you stable assets to tap when your stock holdings are down. But all too often, investors accept a lot of extra risk in exchange for slightly higher-yielding bond holdings, choosing funds that dabble in lower-quality debt and behave too much like stocks, says Allan Roth, a financial planner at Wealth Logic, in Colorado Springs, Colo. "Take your risks with equities," he says. "Have your bonds be the most boring part of your portfolio."
The reasons become all too clear when markets go into a tailspin. In 2008, the average intermediate-term bond fund lost about 5%. That doesn't sound bad compared with stocks' 37% decline, but it was painful for retirees who didn't have any solid ground in their portfolios and were forced to sell holdings at a loss to cover living expenses. Some high-quality, plain-vanilla bond funds, however, were standouts in an otherwise abysmal year. The iShares Core U.S. Aggregate Bond exchange-traded fund (symbol AGG), for example, which tracks the Bloomberg Barclays U.S. Aggregate Bond Index, gained nearly 6%.
Fast-forward to the fourth quarter of 2018, when Standard & Poor's 500-stock index fell 13.5%. The average intermediate-term bond fund gained about 0.9%, and straightforward index-trackers again stood out: The iShares ETF gained 1.6%. But not all intermediate-term bond funds avoided losses. Invesco Core Plus Bond Fund, which has a significant stake in lower-quality "junk" bonds, lost nearly 1% in the fourth quarter and finished the year down nearly 3%. Loomis Sayles Investment Grade Bond, which can invest up to 15% of assets in below-investment-grade bonds, lost 0.7% in the fourth quarter and 0.6% for the year.
Those aren't massive losses, but investors should take note when their bond funds are "moving in the same direction as what you're seeing in the equity and risk markets, and not providing a lot of ballast," says Sarah Bush, director of the manager research team for fixed-income strategies at Morningstar.
Look at Bond Funds' Credit Quality
Investors looking for core bond funds that will help them stay afloat when stocks sink should pay attention to the credit quality of fund holdings. A junk-bond stake above the low single digits could be a red flag, Bush says. And steer clear of the highest-yielding funds, which are venturing into riskier territory to boost their income.
Solid options include Vanguard Total Bond Market Index (VBTLX). This fund tracks a version of the Bloomberg Barclays Aggregate Index, which excludes junk bonds, and charges fees of just 0.05%. American Funds Bond Fund of America (BFAFX) has a minimal junk bond stake and gained 1.5% during the fourth-quarter market slide. Buy the fund's commission-free F-1 share class through online brokerages such as Fidelity and Schwab.
While such higher-quality funds should hold up well during times of stock-market stress, they won't necessarily protect you from rising interest rates. (When rates rise, bond prices fall.) One option: Consider high-quality bond funds that keep interest-rate risk well below the category norm, such as Fidelity Intermediate Bond (FTHRX). Its duration is 3.8 years, versus 5.5 for the average intermediate-term bond fund, according to Morningstar. Funds with longer duration will fluctuate more when rates change.
Social Media, Guns, Taxes, Abortion: Fall Supreme Court Cases You Need to Know
Supreme Court The U.S. Supreme Court will hear several cases this fall that could significantly impact your rights and wealth. Here are a few of them to watch.
By Kelley R. Taylor Last updated
Medicaid Managed Care Groups Under Congressional Investigation
Lawmakers question Medicaid MCOs over their high rates of prior authorization denials.
By Joey Solitro Published
What You Must Know About the Different Parts of Medicare
Medicare Medicare can be complicated but we've got you covered. Here is a quick guide to the different benefits provided through each part.
By Jackie Stewart Published
Retirees, It's Not Too Late to Buy Life Insurance
life insurance Improvements in underwriting have made it easier to qualify for life insurance, which can be a useful estate-planning tool.
By David Rodeck Published
Best Banks for Retirees
banking Kiplinger's 2023 list of the best banks for retirees.
By Lisa Gerstner Published
Best Banks for High-Net-Worth Clients
wealth management Kiplinger's 2023 list of the best banks for higher-net-worth clients.
By Lisa Gerstner Published
Stock Market Holidays in 2023: NYSE, NASDAQ and Wall Street Holidays
Markets When are the stock market holidays? Take a look at which days the NYSE, Nasdaq and bond markets are off in 2023.
By Kyle Woodley Last updated
Stock Market Trading Hours: What Time Is the Stock Market Open Today?
Markets When does the market open? While it's true the stock market does have regular hours, trading doesn't stop when the major exchanges close.
By Michael DeSenne Last updated
Bogleheads Stay the Course
Bears and market volatility don’t scare these die-hard Vanguard investors.
By Kim Clark Published
I-Bond Rate Is 4.30% for Next Six Months
Investing for Income I-Bonds issued May 1 to October 31 will have a rate of 4.30%.
By David Muhlbaum Last updated