Bonds have been in the doldrums since last May, when yields sank to record lows. That triggered the Great Rotation into stocks, pushing equities to all-time highs of their own.
But that doesn’t mean you shouldn’t own bonds. Yesterday I wrote that investors need to lower their expectations and accept smaller returns for the time being. Today I have two more tips.
2. Dial down your duration: If you own fixed-income investments, particularly bond funds and ETFs, look closely at the duration. The value of longer-term bonds gets hit hardest as interest rates rise, while the price of short-term bonds is less sensitive to rising rates.
|Energy master limited partnerships can deliver bond-like income without as much risk from higher interest rates.|
For instance, 30-year Treasury bonds, which are more sensitive to interest rates, plunged 15.1 percent in value last year, but 10-year Treasuries declined only half as much.
If you hold individual bonds, you’ll want to carefully consider the maturities of the bonds in your portfolio. Shorter-maturity bonds will hold up better as yields climb. For bond funds and ETFs, the key measure is called duration, essentially the average dollar-weighted maturity of all bond holdings in the fund.
Again, funds with a lower duration will hold up better as interest rates rise because the fund will be able to reinvest at higher yields more quickly.
3. Consider bond surrogates: It’s likely that income-oriented investors will face the persistent headwind of steadily rising interest rates for many years to come: the exact opposite of the bond-market environment over the past 30 years.
If so, you’ll want to consider moving beyond bonds with your asset allocation and instead consider bond-like investments that also provide income.
For example, energy master limited partnerships (MLPs), real estate investment trusts (REITs) and funds or ETFs that invest in higher-yield preferred stocks can deliver bond-like income without as much risk from higher interest rates. In fact, I have personally researched and recommended several ETFs that yield more than 30-year Treasury bonds, including some that pay monthly dividend income.
And then there are just plain-old blue-chip stocks. Many large-cap stocks in the S&P 500 Index offer dividend yields that match or exceed the income generated from long-term bonds. Of course, stocks face unique risks of their own, but if you focus on high-quality companies with little or no debt and a consistent track record of growing dividends, you can have the best of both worlds: current income, plus the potential for a growing yield over time and capital appreciation, which bonds just can’t match.