After the historic losses bond investors suffered the past two years, it’s no wonder they are content to stash more than $6 trillion in money-market funds at brokerage firms. But cash won’t yield an annual return of 5% forever. When the Fed starts cutting short-term interest rates in 2024 or early 2025, those yields on cash will shrink rapidly. Some bonds, though, will shine because bond prices tend to appreciate when interest rates fall. Here’s what to do…
If you want to invest now: Put cash in a ladder of Treasury Inflation Protection Securities (TIPS). TIPS are attractive for conservative investors who want to preserve purchasing power. You can earn a rate about two percentage points above the recent inflation rate. Purchase individual TIPS at TreasuryDirect.gov.
If you want to invest once the Federal Reserve starts cutting rates: The right kind of bond exposure will depend on why rates are being cut…
Scenario #1: The economy falls into a recession, and the Fed cuts rates rapidly to stimulate economic growth. What to do: Invest in long-term US Treasuries individually or through an ETF such as Vanguard Long-Term Bond ETF (BLV). Prices of long-term bonds will surge as investors flock to them for safety, and yields will be higher than those in money-market funds.
Scenario #2: The economy remains healthy, but inflation keeps dropping until it reaches the Fed’s target rate of 2%. The Fed responds with small, gradual interest rate cuts. What to do: Buy short-term corporate bonds through the Vanguard Short-Term Investment-Grade Fund (VFSTX) and mortgage-backed securities through the Vanguard GNMA Fund (VFIIX). These bonds fluctuate little during rate cuts so you will still earn a decent yield.
