There has been 9 rate hikes in the US since 2015. However it has been about half a year since the last hike. With uncertain factors such as the ongoing trade war with China, and the geopolitical turmoil surrounding oil make the Federal Reserve more hesitant to continue raising rates. WTI price increased by over 33% since the end of last year. The S&P 500 Index is near all time highs, thanks in part to the monetary policy over the last decade or so since the great recession. But if the Fed continues to tighten as the economy become stronger then stock investors may seek out better risk/reward asset classes such as bonds.
In terms of risk, it’s important to realize that there is an inverse relationship between interest rates and the value of a bond. Usually as rates rise, existing bonds with lower yields will fall in value as new bonds with higher yields attract buyers. Some economists are predicting more rate hikes to come, while others argue that the next interest rate move will actually be a drop. Even the Federal Reserve itself has not indicated which direction is more likely in the future, given the recent unexpectedly soft inflation data. So if you’re concerned about an imminent stock market correction, here are 3 bond funds you can consider adding to your portfolio.
Vanguard Short-Term Treasury ETF (VGSH)
If you’re worried about higher interest rates, one way to limit your exposure to volatility in the near future is to shorten the duration of your bonds. With an average maturity of merely 2 years, the bonds in VGSH are much less sensitive to Fed policies a year or two down the line. Due to the nature of short duration assets, the current annual yield on this fund is only 2%. I think of this ETF as a good place to park some money temporarily as I wait for a better investment opportunity, and do not think VGSH is a good long term hold for large sums of savings.
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Vanguard Total Bond Market Index Fund ETF (BND)
This is one of Vanguard’s most popular index funds managing over $200 billion of assets. The expense ratio is only a tiny fraction at 0.035% so this is a very efficiently run fund. It’s a broad fund that covers all spectrum in the investment grade bond market including government, industrial, finance, utilities, and mortgage-backed assets. What you get a relatively stable yield which is currently at 2.8%, and a large amount of diversification.
iShares iBoxx Investment Grade Corporate Bond ETF (LQD)
Finally if you are looking for potentially higher returns and are willing to take a bit more risk, this iShares bond ETF may be a good option for you. As the name points out, this fund only invests in investment grade bonds issued by corporate entities instead of governments. In terms of sector diversification about a quarter of the issuers are in the financial sector. Another quarter belongs to consumer businesses. And communications, technology, and energy companies each account for roughly one tenth. About half of the holdings have a credit rating of BBB, which is lower than the other 2 funds mentioned above. But that greater risk comes with a 3.5% yield which is higher than its broader-based peers, appealing to investors looking for more income.
There are many other fixed income funds in the public market, including some that seek out high yield bonds (or junk bonds.) Those definitely offer higher yields, but they are also the most likely to run into problems when the economy slows down. In any case, in order to balance out the growth potential and higher risks of stocks, adding some bond funds into the mix can reduce volatility in a portfolio.