Bonds still have a big role to play in your portfolio

• Despite a rough first half of 2022, bonds still have an important role to play in your portfolio, offering potential income, diversification, and capital preservation.
• After adjusting to the Fed’s rate hikes, short-term corporate bonds may now offer potentially higher yields than dividend-paying stocks, and historically are less-volatile investments.
• 20 years after iShares launched the first bond ETFs, investors are increasingly turning to bond ETFs as a low-cost, efficient way to customize their fixed income portfolios.

Investors felt the pain across both stocks and bonds in the first half of 2022.

The stock market posted its worst first half since 1970, while the bond market had its worst first-half return on record.  It is truly rare for stocks and bonds to decline at the same time. Going back to 1929, there have only been three years where bonds didn’t go up when stocks went down. The most recent example was more than fifty years ago, in 1969.¹

With the bond market failing this year to balance out stock market fluctuations, many investors may be asking: What are the pros and cons of investing in bonds right now?

While past returns don’t guarantee future performance, bond ETFs have historically provided ways for investors to diversify portfolios, seek income and potentially preserve capital. Still, investors may need to rethink how they’re using fixed income and the mix of bonds in their portfolios, as detailed below.

Income – What’s fixed income without the income?  Investors can use bonds to seek income as most bonds make payments, known as a coupon, to bondholders on a regular schedule. Since the Federal Reserve started raising interest rates, bonds can potentially provide more income; the yield on the 10-year U.S. Treasury note rose 92 basis points from March 31, 2022 to July 31, 2022.²

Although there’s no guarantee the current situation will continue, short-term corporate bonds may provide similar levels of income as dividend paying stocks. Both assets are, on average, currently yielding over 4% – the first time short-term corporate bonds and dividend-paying stocks have offered the same level of yield since at least 2015.³ And these bonds historically come with much less volatility and lower drawdown risk (a measure of the time it takes to recoup losses) vs. their equity counterparts.⁴

Bonds with more credit risk, such as high yield or emerging market debt, may offer even higher levels of income, or yield. Credit risk refers to the likelihood a bond issuer will make their regular payments on time.

Diversification – Keeping bonds in the mix of your investments can potentially improve your overall long-term returns. As noted above, bonds have historically provided investors a counterbalance to stocks, especially in down years. History also suggests bond performance has tended to be good following periods of weakness in bond prices -which move in opposite direction as bond yields. The average three-year annualized returns of bonds following a three-year period in which they lost money is 11.6%.⁵ Furthermore, bonds may potentially offer more income to buffer against future price drawdowns as the market adapts to higher interest rates and tighter financial conditions.

Capital Preservation – Bonds can be used to help preserve the value of your savings and potentially provide more yield than idle cash. Investors seeking this goal should consider their time horizon, liquidity needs and risk tolerance to any loss of capital. Shorter maturity bonds have tended to change in price less than longer maturity bonds and may be beneficial during periods of rising rates.

In July 2002, iShares launched the first bond ETFs with a Corporate Bond ETF and four Treasury ETFs. Twenty years later, bond ETFs have grown to $1.5 trillion in assets under management. We now project that bond ETFs will reach $5 trillion by 2030.

Bonds still have a big role to play in your portfolio and bond ETFs are a low cost, efficient way to access them.