Why invest in longer-term bonds when treasury bills, or even money market funds, offer comparable yields? It’s a question we’re often asked, but despite the flat shape of the yield curve, we think investors should still hold some longer-term investments rather than waiting or hoping for yields to move higher. Bond barbells or ladders are two strategies to consider.
I’m Collin Martin, and this is Bond Market Today.
A bond barbell is a strategy that focuses some holdings on short-term maturities, and other holdings on longer-term maturities, and a bond barbell can offer investors two key benefits compared to holding just short-term bond investments. The first benefit is locking in yields. Now, longer-term bonds don’t offer much of a yield advantage, if any, relative to short-term bonds, but at least you can lock in those yields with certainty. Now, with a rising possibility that the next Federal Reserve move could be a cut, investors holding short-term bond investments could be face with lower yields when those bonds come due. So, we think it’s important to lock in these yields with certainty.
The second benefit is diversification. Longer-term bonds are more sensitive to interest rate changes. So, if the next move by the Fed were a rate cut, or if treasury yields were to move lower for some other reason, longer-term bond prices would generally move higher than shorter-term bond prices. Now, short-term bonds are generally pretty liquid, and their prices tend to be relatively stable, but they’re not going to offer much in terms of price appreciation if market volatility were to pick up.
A second strategy to consider is a bond ladder, or a portfolio of individual bonds with staggered, or laddered, maturity dates. A bond ladder is meant to provide predictable income, with the flexibility to reinvest bonds as they mature. Now, we think bond ladders can help take the guesswork out of investing. They allow you to stay invested, regardless of where interest rates are going. Bond ladders have two primary goals in mind. The first is to help reduce risk. By investing in a bond ladder, it allows investors to avoid locking in a single interest rate, and it helps smooth the effects of fluctuating interest rates. If yields rise, you can take the proceeds of maturing bonds and reinvest them at those higher yields. If yields fall, it’s true that you’ll be reinvesting at lower interest rates, but you’ll already have some higher-yielding bonds in your portfolio from when you initially put the ladder together.
A second goal of a bond ladder is that it can help you manage cash flows. Since bonds make semi-annual interest payments, you can construct a bond ladder with bonds that pay interest that align with your liabilities, and you can use the proceeds of maturing bonds to either reinvest in new bonds to keep the ladder intact, or you can use the proceeds as a source of cash funding.
So, even when the yield curve is flat, we think bond barbells and ladders are good strategies to consider rather than just focusing on short term bond investments.
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