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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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