Now is a great time to buy long-term bonds, and there are two ways to do so.
The Federal Reserve appears on track to cut interest rates for the first time since 2020 at its policy meeting in late September. Rate cuts are expected to continue through 2025, with the median forecast at the time of writing being for a total cut of 2.25 percentage points in the benchmark federal funds rate by the end of next year.
As we appear to be entering a lower interest rate environment, now may be a wise time to start considering strategically adding some fixed income exposure to your portfolio. Here, we highlight two ETFs in particular that are worth a closer look and explain why now may be a great time to buy.
Two noteworthy bond ETFs
We'll get to the “why now” question in the next section, but for now, here are two long-term bond funds that look attractive right now.
first, Vanguard Extended Duration Treasury ETF (EDV 0.17%)The fund has an extremely low expense ratio of 0.06% and a current yield of 4.2% and invests in an index of long-term (20-30 year) U.S. Treasury bonds. The average maturity of the bonds in the portfolio is 24.6 years and the average yield to maturity is 4.5%.
Secondly, Vanguard Long Term Bond ETF (BLV 0.34%) It's similar in nature but broader in focus: About half of this ETF's assets are in long-term government bonds like Treasurys, and the rest in investment-grade corporate bonds. This gives it a higher overall yield (currently about 4.7%). Its expense ratio is even lower, at 0.04%.
This means that long-term bond ETFs have higher yields and lower costs. The biggest drawback is that, unlike government bond ETFs, there is credit risk associated with the companies that issue the bonds. This makes the ETFs more volatile, especially in volatile markets.
Why now?
The Federal Reserve is widely expected to begin cutting interest rates when it meets later this month and continue to gradually lower them for at least the next year or so. Bond yields, especially the longer-term bonds that these ETFs hold, tend to move in the same direction as the federal funds rate. And because yields and prices have an inverse relationship, a fall in current bond yields could drive up the prices of these ETFs.
In other words, these ETFs hold portfolios of long-term bonds, many of which currently have relatively high yields. As yields on new long-term bonds fall, the bonds already held by these two ETFs become more valuable.
To illustrate this, let's look at how these two ETFs performed during the 2022 and 2023 rate hiking cycle.
While there's no way to predict future performance (or Fed interest rate decisions) with complete accuracy, these ETFs are likely to rise if interest rates fall significantly.
To be clear, both of these ETFs are great buy-and-hold investments for those who want more exposure to bonds, and now may just be the perfect time to add more before interest rates start to fall.
How much exposure to fixed income should you have?
there is no perfection While we don't know the answer to this question, one common guideline financial planners use is to subtract your age from 110 to determine how much of your investment assets you should have in stocks and the rest in bonds. For example, I'm 42 years old, so this means I should have about 68% of my money invested in stocks and 32% in fixed income instruments like these two funds.
Admittedly, I tend to use this as a guideline rather than an absolute rule (not that 32% of my portfolio is exactly devoted to bonds), but it's a good indicator of an age-appropriate investment mix, so if your portfolio is a little less exposed to bonds, a top-quality ETF like this one might be the solution.
Matt Frankel has no investment in any of the stocks mentioned herein. The Motley Fool has no investment in any of the stocks mentioned herein. The Motley Fool has a disclosure policy.
