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 (BSV) , which tracks investment grade bonds, has a 2.7 year duration and the iShares 1-3 Year Treasury Bond ETF (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.”
Investors can also hold onto individual bonds until maturity to avoid realizing a short-term loss as they would regain the initial principal once the security matures plus interest payments. This is where target-date ETFs come into play. Target-maturity ETFs options from Guggenheim and BlackRock’s iShares only hold bonds that mature in a set year and distributes cash back to investors upon maturity. [Target Date Bond ETFs Reduce Rate Risk]
Additionally, bond investors should also keep in mind credit quality exposure. High-yield, speculative grade, junk bonds tend to perform more like stocks.
Investors who are seeking a little extra bump in yields can consider junk bond ETFs, and some sponsors now offer short-duration options to help limit rate risk. The SPDR Barclays Short Term High Yield Bond ETF (SJNK) has a 2.13 year duration and a 3.84% 30-day SEC yield, and iShares 0-5 Year High Yield Corporate Bond ETF (SHYG) has a 2.14 year duration and a 3.40% 30-day SEC yield.
For more information on bonds, visit our bond ETFs category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Mr. Lydon serves as an independent trustee of certain mutual funds and ETFs that are managed by Guggenheim Investments; however, any opinions or forecasts expressed herein are solely those of Mr. Lydon and not those of Guggenheim Funds, Guggenheim Investments, Guggenheim Specialized Products, LLC or any of their affiliates. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.