Rate cuts in 2019 may have tamped down any sizeable gains in the fixed income exchange-traded funds (ETFs), but bonds in general are still an essential component in an investor’s portfolio. In an interview with Morningstar’s director of personal finance, Christine Benz, she discusses why fixed income is necessary.
“Well, the key reason is that you earn some type of income depending on the bond,” said Benz. “And that income is quite stable because the bond issuers are held to deliver that income to people who purchase their bonds. So, it’s a stable source of income. Income is not really high. So, when you compare long-term bond returns relative to stocks, it’s nothing to write home about. The big advantage from a portfolio standpoint is that bonds are really the stabilizers for your portfolio. So, your equities are going to be more volatile. They’ll have periods where they will perform really well. They’ll have periods where they’ll be in a downswing. The bonds tend to just perform steady as she goes. Especially as you get older, and you get closer to needing your money, you want to care more about that stability. And that’s what bonds bring to the table.”
When an investor is looking to get a taste of fixed income, should they keep the short or long term horizon in mind?
“Well, I would say the key thing is probably to focus on your time horizon–your proximity to needing the money,” said Benz. “So, if you have a very short-term time horizon of like a couple of years–so maybe it’s like next year’s tuition bill or the property tax bill or something like that–you probably want to keep the money very safe. You’d want to keep it in true cash investments. Cash investments mostly are FDIC-insured. Money market mutual funds are a separate category; they’re not. But these investments are all but guaranteed if not guaranteed. So, near-term spending, keep that money in cash.”
“Then, if you have, say, a two- to three-year time horizon, I think that a short-term bond fund, kind of a core short-term fund that might own a gamut of different bond types from government bonds to some high-quality corporate bonds, maybe some mortgage-backed bonds, that can make sense,” Benz added.
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Investment-grade corporate bond-focused fixed-income ETF options include the iShares Intermediate Credit Bond ETF (NASDAQ: CIU), iShares iBoxx $ Invmt Grade Corp Bd ETF (NYSEArca: LQD) and Vanguard Interm-Term Corp Bd ETF (NASDAQ: VCIT). Investors looking for broad-based core bond exposure can look to a fund like the iShares Core US Aggregate Bond ETF (NYSEArca: AGG).