When it comes to equities, you want to give your clients a basket that contains exposure to a well-rounded mix. You might have some health care sector exposure, a little bit of oil and a single-country fund.
Are you approaching bonds the same way? If not, you should be.
Not all bond types are created alike – some are more tax efficient, some do better in low-interest rate environments, others do better in improving economic times and so on.
Bond exchange traded funds (ETFs) make it easy to get this level of diversification, and your options range from the safer U.S. Treasuries to high-yield bonds, and they come in a range of maturities and ratings. Bond ETFs can be divided into four primary categories: U.S. government, municipal, corporate and international.
TIPS for Inflation
Another option you have in the bond space is TIPS: Treasury Inflation-Protected Securities, which are meant to be used in inflationary environments.
As consumer prices increase, the interest from bonds becomes worth increasingly less. When bond yields are high, this isn’t much of an issue, but right now bond yields are low. Inflation could sock investors once it kicks in. But that’s not all: when inflation kicks in, the government tends to raise short-term rates.
One option to hedge against inflation is through TIPS, which are bonds with built-in inflation protection.
TIPS are similar to regular Treasury bonds in that they have the same credit risk – effectively none – and they’re issued by the government. But the difference is how they pay the coupon. If you buy $100 at inception and the rate of inflation is currently 2% for 10 years (the date of maturity), the principal will grow 2% each year.
U.S. Government Bonds
U.S. government bonds, or Treasuries, are generally considered to be the safest investments around.
The argument for owning Treasury bonds is that the economic recovery may be slow going at best. But even in that environment, the protection may be short-lived. Investors have rushed to buy Treasury securities since late April, in the process driving market yields on the bonds sharply lower.
When interest rates rise, the prices on these bonds may fall, and investors still in them will lose principal if this happens.
Gone are the days of making easy money in the Treasuries market. The factors that fueled the bond boom are becoming unraveled: the inflation decline, and the sharp drop in market interest rates. Also, on a global scale, investors began fleeing to Treasury bonds as a safe haven when the market went bust.
Fiscal tightening makes it more likely that the Federal Reserve and the European Central Bank, among others, will keep short-term interest rates near rock-bottom a while. This is presenting a fertile environment for investors and providers to offer and seek out Treasury bond funds.
Still, if you are worried about interest rates, short-term bonds may a good choice since they are less influenced by changes in interest rates.
The only possible risk in the Treasuries market would be a colossal economic downturn or a large-scale war that would prevent the government from repaying short- or long-term debt obligations, so keep this in mind.
You can easily keep track of the performance of Treasury bonds by signing up for alerts, which will send you an email when a trading opportunity has been reached.