In recent years, many investors have wondered why they should own bonds at all…especially during a brutal bond bear market when you could earn a risk-free 5% yield on cash in a savings account at an FDIC-insured bank.

But it’s time to get ready for a bond revival, says fixed-income strategist Robert M. Brinker. The Federal Reserve will continue to cut short-term interest rates as it pursues its dual mandate—to lower inflation while maintaining stable economic growth and low unemployment.

Remember the golden rule of bond investing: A bond’s yield typically moves in inverse proportion to its price. So when interest rate cuts cause bond yields to fall, the value of your existing bonds increase in price. That should help launch a new bull market in bonds.

Bottom Line Personal asked Brinker how bond investors can best position themselves this year, as well as what bond types to avoid and which government, municipal, high-yield and corporate bond funds to favor…

Bonds Make Sense Again

The bond market went nowhere most of last year, churning sideways as the Federal Reserve maintained short-term interest rates at a peak of 5.4%. Then, in mid-September, the Fed slashed rates by one-half percentage point, easing monetary policy for the first time in four years. Then cut them again in November. For 2025, I expect to see most areas of the bond market in positive territory thanks to significant shifts in four major factors…

  1. Short-term interest rates will drop to a range of 3.5% to 4% by year-end. That means the total return you receive from bonds (yield plus capital appreciation) should be more attractive than the shrinking yields you can get on cash in your savings account. 
  2. The inflation crisis is nearly over. By the end of 2025, I expect inflation, as measured by the Consumer Price Index, to shrink to 2% to 2.25%. That’s close to the Fed’s optimal target rate of 2%.
  3. The US economy will achieve a soft landing. I’m forecasting annual gross domestic product (GDP) growth of 2% for 2025 and a year-end unemployment rate of 4.5% (up slightly from the recent 4.1% level).  That’s a “Goldilocks” economic environment for bonds—not too hot, not too cold…just right. We should skirt a recession that would cause bond yields to fall much lower but also avoid the economy heating up, which might require the Fed to start hiking interest rates.
  4. Stock market valuations are stretched. The S&P 500 repeatedly hit record highs and advanced more than 50% over the past two years. The average forward price-to-earnings ratio (P/E) of the index is historically high at 22. I expect money to flow into bonds as investors reduce stock-heavy allocations to stabilize their portfolios against up-and-down market swings.

My strategy for 2025…

  • Very conservative bond investors can stick with cash in high-yield savings accounts as long as short-term interest rates stay above 4%. After that, consider deploying your money into short- and intermediate-term term high-quality corporate bonds. These categories are my fixed-income “sweet spot” for 2025. Reason: Corporate bonds should pay higher total returns than savings accounts or comparable Treasury bonds without much added risk.
  • Moderate and aggressive bond investors should consider mortgage-backed securities (MBSs), which are large groups of high-quality residential home mortgages bundled together and sold as investments, many backed against default by federal government agencies. I’m also partial to junk bonds, which can offer yields of 5% or more because the stability of the US economy means potential defaults will stay low.
  • Investors in higher tax brackets should consider intermediate-term municipal bonds. Their tax-equivalent yields are more attractive than comparable US Treasuries, but there’s another motivation. Many components of the 2017 Tax Cuts and Jobs Act (TCJA) are set to expire at the end of 2025. This is a huge deal that you’ll be reading about all year. Unless Congress extends or revises the TCJA, tax rates for income brackets will rise. Example: The top marginal federal tax rate would go from 37% to 39.6%.

Which Bond Types to Avoid

While I expect most bond categories to do well in 2025 thanks to falling interest rates, one area looks much less appealing—long-term US Treasury bonds. With maturities of 10 years or longer, Treasury bonds are far more prone to price fluctuations than their shorter-maturity counterparts. They offer little value for the particular risks you’re taking on now. Reason: Long-term Treasury yields aren’t dictated by the Fed. They hinge on the bond market and investor sentiment about inflation and economic growth. That means unless we have a deep recession, you will not see sharply lower yields or sharply higher capital appreciation from long-term Treasuries. In fact, given the relative strength of the US economy now, long-term yields actually were rising toward the end of 2024. If inflation should happen to reignite, yields on long-term Treasuries could hit 5% or higher. That would cause the prices of these bonds to plummet. 

Best Bond Funds for 2025

Vanguard Short Term Corporate Bond ETF (VCSH) owns more than 2,600 high-quality corporate bonds from companies with strong balance sheets such as Anheuser-Busch InBev and Bank of America. The passively managed portfolio tracks the Bloomberg US 1-5 Year Corporate Bond Index and offers very low volatility. Recent yield: 4.63%. Performance: 2.3%.* Vanguard.com

Vanguard Intermediate-Term Corporate Bond ETF (VCIT). The sibling of VCSH holds 2,200 holdings with an average credit rating of BBB+ and follows the Bloomberg US 5-10 Year Corporate bond index. The fund has the potential for wider price swings than VCSH but compensates investors with higher yields and better long-term performance. Recent yield: 5.04%. Performance: 2.8%. Vanguard.com

Vanguard Intermediate-Term Tax-Exempt Fund (VWITX) owns an actively managed portfolio of about 1,800 municipal bonds with federally tax-free yields issued by well-managed states such as Texas and Virginia. The fund is conservatively run and has performed consistently well. For investors in the highest federal income tax bracket, the recent 3% yield translates into a 4.97% yield. Performance: 2.2%. Vanguard.com

DoubleLine Total Return Fund (DLTNX) is managed by Jeffrey Gundlach, regarded as one of the best fixed-income managers in the country. Gundlach specializes in MBSs and uses a “barbell” approach, mixing stable, low-yielding mortgage securities with riskier high-yielding ones that aren’t backed by federal agencies. Recent yield: 5.58%. 10-year performance: 1.7%. DoubleLine.com

Osterweis Strategic Income Fund (OSTIX) uses a  unique strategy to provide high yields and reduce excessive volatility common  to many junk-bond portfolios. Manager Carl Kaufman focuses on about 180 short-term bonds with maturities under two years and is willing to hold more than 20% of assets or more in cash if he can’t find attractive investments. Kaufman, who has run the fund for nearly a quarter century, excels at evaluating credit risk. None of his bond holdings have ever experienced a default. Recent yield: 6.1%. Performance: 4.5%. Osterweis.com

*All mutual fund performance is annualized for 10 years through November 8, 2024.

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