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Bad News Bonds

William Ehart

EXPERTS HAVE LATELY been recommending that investors shift some money from short-term bonds—which offer the highest yield these days—to longer-term issues, whose prices are more sensitive to interest rates.

Had I followed this advice—and I almost did—I’d have quickly lost money in what’s supposed to be the safe part of my portfolio. Bonds did indeed rally from their October 2022 lows, but have pulled back since early May. Vanguard Intermediate-Term Treasury ETF (symbol: VGIT) was down 4.2% from its May 4 peak through last Friday, while iShares 20+ Year Treasury Bond ETF (TLT) was off 8.8% during that stretch.

The “smart money” said prepare to profit if interest rates fall, perhaps because the economy slips into a recession. But that’s a big “if.” The flipside: You lose if rates rise.

That’s why I’ve generally preferred short-term Treasurys in my portfolio. That limits my exposure to interest-rate fluctuations and provides a hedge against the risk of falling stock prices. Short-term Treasury prices won’t decline much if rates keep rising, though they also won’t gain much if rates fall from here.

An added bonus: Today, we’re enjoying generous yields on short-term bonds and cash investments, including some guaranteed by the federal government. Indeed, those high rates have lately drawn me to money market funds and certificates of deposit (CDs).

The bond market got a bad case of the willies in August, burning those who hold interest-sensitive assets. Now, Wall Street is gripped by the fear of rising rates. Budget deficits and the national debt really do matter—finally—or so some are saying. On top of that, the U.S. Treasury must issue a lot of new debt at higher rates, while foreign countries are reducing their Treasury holdings. Prepare for interest rates to be “higher for longer,” some experts are predicting.

I prefer not to bet on the direction of interest rates—and I don’t have to. Unlike the stock market, where declines have reliably been followed by greater gains because of growing earnings and dividends, there’s no such natural tendency in the bond market. Yes, higher interest rates lure more buyers, but rates could potentially rise indefinitely. Until 2022, bond and stock investors, as well as homeowners, had enjoyed 40 years of generally falling rates. Who’s to say that trend couldn’t reverse in the decades ahead, and so why take interest-rate risk?

I have a young advisor at Fidelity Investments who had better advice for my situation than the high mucky mucks at other big asset-management firms. He had thoughtfully set up a meeting with me ahead of the Aug. 31 maturing of a Treasury note I bought last year.

He said Fidelity shared the consensus view that interest rates will fall in 2024. But knowing we were talking about my emergency money, his recommendation wasn’t to take interest rate risk, but rather to focus on avoiding reinvestment risk—the danger that rates will be lower when I go to reinvest the money from, say, a maturing bond. He suggested buying a noncallable three- or five-year CD at 5.1%. That way, if rates decline, I don’t have to worry about where to reinvest my cash: I’ve locked in good rates for a few years to come.

Problem is, I can’t commit to tying up any money for three-plus years. I need more liquidity in my emergency fund. I can tie some up for perhaps a year or 18 months. Of course, if rates keep rising, I’d be better off in a money market fund. Last year, I bought that Treasury note with what seemed like a great yield, but it’s now low by today’s standards.

I’ve settled on a plan to gradually purchase CDs between now and year-end to create what’s known as a CD ladder. That is, the CDs will mature at staggered dates, stretching from June 30, 2024, through Sept. 30, 2025. Every three months starting in mid-2024, I’ll get cash I can reinvest or spend if needed, such as if I lose my job or to pay for my daughter’s wedding. I recently bought a noncallable CD yielding 5.25% through Sept. 4 of next year. In a month, I’ll look for one maturing in December 2024, then March 2025 and so on.

Moving gradually eases my mind about the possibility that rates could be even more generous in the near future. The lesson I’ve learned from the whole experience: Tune out tactical investment advice—and just be happy when yields in your emergency fund are beating inflation.

William Ehart is a journalist in the Washington, D.C., area. In his spare time, he enjoys writing for beginning and intermediate investors on why they should invest and how simple it can be, despite all the financial noise. Follow Bill on Twitter @BillEhart and check out his earlier articles.

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Kevin Rees
1 year ago

Fidelity also has a “CDladder tool”. You decide on the longest term (12 months, 24 months, or whatever) and the total amount to invest (a multiple of $4000).

So, for example, if you picked $20,000 and 12 months, the tool will pick the best yielding 3, 6, 9, and 12 month CDs s add and propose them for purchase. You can also decide if you want “auto rollover” when you buy. If you select that option each CD will be reinvested in a new 12 month CD when it matures.

painless, simple, and you are always within 3 months of at least one CD maturing.

Nick M
1 year ago

For anyone without a short term bond fund in their retirement account, it’s helpful to know that there really isn’t anything special about a short term bond fund, it’s simply a reduced duration bond fund. You can accomplish an equivalent by holding both an intermediate term bond fund and Treasury bills (or a Treasury Money Market fund).

For example, a short term bond fund like VBIRX will have performance very similar to instead holding 60% in intermediate term bond fund VBTLX and 40% in a money market fund.

Michael1
1 year ago
Reply to  Nick M

That’s an interesting way to think about it.

Michael1
1 year ago

For those of us who like the general idea of staying with short government bonds, the difference that just going longer within the category makes is notable.

SGOV tracks the ICE 0-3 Month US Treasury Securities Index, has a 12 month yield of 3.54%, 1yr return of 3.8%.

SHV tracks the ICE Short U.S. Treasury Securities Index, (Treasuries with less than one year until maturity), has a 12 month yield of 3.35%, 1yr return of 3.4%.

VGSH tracks the Bloomberg 1-3 year Treasury index, has a 12 month yield of 2.3%, 1yr return of 0.16%

FUMBX tracks the Bloomberg 1-5 year Treasury index, has a 12 month yield of 1.4%, 1 yr return of minus 1%.

Of course this is right now, and the direction of the difference would change if interest rates were to go down.

Randy Dobkin
1 year ago
Reply to  Michael1

And here are 30-day yields as of 7/31:
SGOV: 5.29%
SHV: 5.05%
VGSH: 4.98%
FUMBX: 4.70%

Andrew Forsythe
1 year ago

Thanks for this, Bill. Schwab’s bond experts have likewise been recommending going longer on bonds recently. But, in line with Jonathan’s and Adam Grossman’s philosophy, I’m mainly staying short term with bonds and cash and taking my risk with equities. It’s hard to pass up the simplicity and liquidity of MM funds these days when they’re paying north of 5%.

Jack Hannam
1 year ago

I enjoyed reading this article Bill. I share your concern about interest rate risk and it’s potential effect on longer term bonds. I agree with Jonathan and others in taking risks with my equity allocation, but avoiding risks with my bonds, sticking with cash and short term treasuries. The main risk faced by the latter is inflation. I accept that risk, remembering that the purpose of my cash and short term bonds is not to provide growth, but to allow for annual withdrawals without needing to sell stocks at depressed prices. And the opportunity to buy more stocks when on sale during bear markets, via rebalancing.

Joe Cyax
1 year ago

Lots of good logic.  

For those who do not want to tie up funds more more than a year, one other consideration for those of us in high tax states is to compare any 1 year CD rate with what you are likely to get on a 52 week T-bill (not subject to state tax). I have been doing that for a couple years now and with my state’s take (~ 6% of interest), I have found treasury bills a better deal for a year or less.

w0_0dy
1 year ago
Reply to  Joe Cyax

another benefit of going the treasury bill route with emergency funds is the cost of liquidation should an emergency need arise. should be less costly to sell a treasury than a brokered CD in the secondary market

billehart
1 year ago

Thanks Michael. Yes, the Fidelity advisor spoke about getting out of the CD early if necessary. I probably should have been more open to that.

Michael1
1 year ago

That’s a great article Bill. Two comments:

On the recent decision about your emergency money, I think it would have also been okay to go with the recommended three to five year term. Ladders strike me as better suited for money you actually intend to spend in a schedule. Emergencies (end emergency money) don’t work like that, and indeed we hope to not actually need to tap an emergency fund, so the longer CD would be fine; just pay the penalty for early withdrawal if you need to. You could also buy not one CD but several, so if you do need the money, you don’t necessarily have the pay the penalty to get the whole among, but can just unlock the amount you need. Of course also fine to do what you did, or to just leave it in the money market. 

On your decision to stick with shorter term bonds, this was just what I needed right now, as I’ve also been hearing the noise about longer terms. Now I’m talking about long term allocation, not emergency money. We do hold an intermediate term core-plus fund as part of our bond allocation, which of course has lost money lately, and have no intention of making tactical changes to it. For the larger amount we have sitting in cash, the longest we go may be to move some to a short government bond fund. 

Much comes down to thinking about what the money is for. 

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