Despite the recent pullback in equities, markets still appear strong . Investors may be tempted to eschew fixed-income assets in favor of full equity exposure, but bond exchange traded funds still have beneficial diversification qualities.
“Diversification is the equivalent of diet and exercise,” certified financial planner Kent Grealish, of Grealish Investment Counseling, said in a CNBC article. “It is a little boring, sometimes a bit painful, and it can take a while to see any results.”
While diversifying with bonds may dampen overall gains in an equities rally, the fixed-income assets help mitigate volatility during a stock market pullback.
After the three-decade long bond market rally, investors are now wary of a rising interest rate environment – bond prices fall as interest rates rates, and vice versa. Interest rate risk is certainly a consideration, and investors should act accordingly.
For starters, retirees approaching retirement should limit their exposure to interest rate risk by shifting into short duration bond funds – duration is a measure of a bond fund’s sensitivity to changes in interest rates, so a shorter duration translates to a lower impact on the bond fund’s performance if interest rates do rise. For example the Vanguard Short-Term Bond ETF (NYSEArca: BSV), which tracks investment grade bonds, has a 2.7 year duration and the iShares 1-3 Year Treasury Bond ETF (NYSEArca: SHY), which tracks short-term Treasuries, has a duration of 1.92 years. [Hedge Against Market Turns with Short-Term Bond ETFs]
“While you can never eliminate risk, you can minimize it,” Peter Ashby, a certified financial planner and founder of Adams Ashby Financial Advisors, said in the article. “If you have a short time horizon or an active investment strategy, you might consider decreasing the duration of your fixed-income portfolio.”