Investors have been piling in on bonds to seek refuge from the recent market volatility, but is core bond exposure enough? Should they start looking to other avenues of the bond market for more returns?
“I think a core starting point for investors adding fixed-income exposure to their portfolios would be to think about the short- and intermediate-term core bond categories,” said Morningstar’s director of personal finance Christine Benz. “So, the idea there is that you are getting pretty low returns–and it will ebb and flow based on the time period–not great returns, but you’re getting great stabilization for your portfolio. If the idea is that you’re getting closer to needing your money for spending, which is why most people own bonds, that you want to keep things pretty bland and boring, and short and intermediate-term bonds tend to deliver–they tend to perform well in periods when equities are falling, which is what you want from your bond portfolio.”
Given the challenges in the fixed income market, where are the opportunities beyond core bond exposure?
“One of the key categories that comes to mind would be Treasury Inflation-Protected Securities,” said Benz. “So, a key thing to know about bonds in general is that inflation is the natural enemy. It’s your natural enemy as a bond investor, because it eats away at the purchasing power of the interest that you earn from that bond. And so, Treasury Inflation-Protected Securities nicely address that problem by offering a little bit of a bump up in your principal value when inflation is running up. Recently, inflation hasn’t been anything to worry about.
“But I think that it’s worth keeping in the back of your mind because you don’t know when inflation will flare up. It’s really hard to predict,” Benz added. “So, I think that this is an interesting sort of secondary category to consider. You definitely want to hold them within the confines of a tax-sheltered account because they are taxable bonds and plus that inflation adjustment that you receive is also taxable.”
TIP seeks to track the investment results of Bloomberg Barclays U.S. Treasury Inflation Protected Securities (TIPS) Index (Series-L) which composed of inflation-protected U.S. Treasury bonds. The fund generally invests at least 90% of its assets in the bonds of the underlying index and at least 95% of its assets in U.S. government bonds.
It may invest up to 10% of its assets in U.S. government bonds not included in the underlying index, but which BFA believes will help the fund track the underlying index. It also may invest up to 5% of its assets in repurchase agreements collateralized by U.S. government obligations and in cash and cash equivalents.
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