There are no signs that the record low interest rates we are seeing in 2020 will change. Jerome Powell, the chair of the Fed, recently declared his desire to maintain low rates at least through 2023. Government bond actual yields, or yields after inflation, are nevertheless negative.
Fixed-income investors have difficulties in this context of historically low interest rates, particularly those who are approaching or have reached retirement. There is no magic bullet, but there are a number of approaches you should think about as you negotiate these treacherous waters.
Modify your expectations.
Setting realistic expectations is the first step in fixed-income investing at a period of historically low interest rates. It is ridiculous to anticipate 5% from a low-risk investment given that 30-year Treasury rates are below 1.5% and shorter-duration yields are considerably below 1%. As we’ll see below, there are some fixed-income investments that offer larger rates but also carry more risk.
Sometimes it makes sense to take on extra risk. However, it’s critical to comprehend these risks and how they could impact your total portfolio and financial objectives. This can entail a little bit more credit risk acceptance for fixed income investors. Over the medium run, inflation risks might increase as a result of the Fed’s current open support for higher prices.
After adjusting our assumptions, let’s examine six of the greatest fixed-income investment options that investors seeking to increase returns should take into account.
For a low-rate environment, the best fixed income investments
- Online savings accounts, to start
The interest on a 1-month Treasury note is now less than 0.10%, which is also about the average annual percentage yield (APY) typical banks pay on savings accounts. However, online banks continue to provide rates that are far higher. The APYs for online savings accounts are still historically low, but they provide a secure means to safely increase the income on a demand deposit account.
The current top APYs for internet savings accounts are between 0.50% and 0.80%. Remember that real rates — those calculated after taking inflation into account — are negative. However, compared to most money market accounts or short-term government bonds, online banks do provide far greater rates.
- Secondly, certificates of deposit
Some certificates of deposit (CDs) could have rates that are only a little bit higher than savings accounts. Additionally, they enable you to fix the rate for the duration of the CD. That might be a drawback if rates start to rise once more, but because rates are more expected to continue falling this year, locking in rates on at least a portion of your fixed-income portfolio is a wise decision.
On a one-year CD, rates as high as 0.85% are still available. Remember that rates can and often do fluctuate every day.
An excellent approach for investors to benefit from even greater rates on longer-term CDs while maintaining frequent access to the cash stored in certificates as they mature is through the use of CD ladders.
Additionally, you may find CDs with special characteristics, such as no-penalty CDs, which do not impose a fee if you withdraw your funds before to maturity. Bump-up CDs provide investors the option to raise the CD rate at any time throughout the term if market rates rise. You might be able to increase the rate twice throughout the certificate’s duration, depending on the length. Just remember that these features often have a little-lower APY.
- Corporate Debentures
Corporate debt with investment-grade ratings is one choice if you’re trying to purchase bonds with greater returns. businesses with healthy balance sheets and cash flows are issuing these bonds. Investment-grade bonds are nevertheless viewed as having a reasonable level of default protection, despite having a larger default risk than Treasuries.
A 10-year Treasury now has a yield of around 0.70 percent. A 10-year investment-grade corporate bond, on the other hand, has a yield of little under 2.00%.
Corporate bonds can experience a loss if interest rates rise, just like Treasury bonds might. Fund managers continuously buy and sell bonds in order to preserve the average maturity of a fund over time. In a rising rate environment, selling bonds essentially locks in losses. Because of this, some investors like making direct investments in bonds that they can keep until maturity. This increases investor control over the investment, but it may also be costly and time-consuming.
- ETFs for defined-maturity bonds
An exchange traded fund (ETF) with defined-maturity bonds combines the control of individual bonds with the simplicity of bond funds. These ETFs invest in tens of thousands of bonds in a single fund, similar to a bond fund. Defined-maturity bond ETFs have a defined maturity after which the fund shuts and owners receive their net assets back.
The Invesco Bullet Shares defined-maturity bond ETF may be the most well-known. Investors have the option to invest in corporate, high-yield corporate, emerging market, and municipal bonds with Bullet Shares ETFs. The maturities of these bonds range from one to 10 years.
The kind of bond and maturity affect the yields. For instance, the Bullet Shares 2025 Corporate Bond ETF (BSCP), which matures in 2025, now yields roughly 2.21%, while the equivalent (BSCM), which matures in 2022, yields 2.02%. You may use these Bullet Shares ETFs to ladder, just like CD ladders.
- ETFs for high-yield bonds
Additionally, Invesco provides high-yield corporate bond funds with even greater yields. For instance, the corporate bond fund with the same time to maturity earns around 3% less than the Invesco Bullet Shares 2025 High Yield Corporate Bond ETF (BSJP), which presently yields about 5%.
- Local Government Bonds
Investors may receive better returns and tax benefits from municipal bonds. Federal taxes on Muni income are often excluded, and state taxes may not apply as well. Rates on Munis are hence often lower than those on other comparable bonds.
On an after-tax basis, Munis may present a tempting investment for investors in higher tax rates. In addition, taxable funds should be used to hold Munis rather than tax-advantaged retirement accounts.
It’s critical to keep your investing objectives in mind when you review your fixed-income strategy. For example, why are you adding bonds to your portfolio? Diversification is a factor, in addition to generating a consistent flow of revenue.
Bonds are frequently used in investment strategies to reduce portfolio volatility. Due to this, many investors choose to concentrate on corporate and Treasury bonds with an investment-grade rating. If you choose high-yield or debt from developing markets in an attempt to raise yield, be aware that volatility may rise and that investing a disproportionate amount of your fixed-income portfolio in these riskier securities may negate the initial benefit you sought.