Now could be a great opportunity to buy long-term bonds. Here are two ways to do it.
The Federal Reserve appears set to lower interest rates for the first time since 2020 at its policy meeting later in September. It is expected to continue lowering rates through 2025, and the median expectation as of this writing is a total of 2.25 percentage points of cuts to the benchmark federal funds rate by the end of next year.
As we appear to be entering a falling-rate environment, it could be a smart time to start thinking about strategically adding some fixed-income exposure to your portfolio. Here are two ETFs in particular that could be worth a closer look, and why now could be a great time to buy.
2 fixed-income ETFs to take a closer look at
We’ll get into the question of “why now” in the next section, but here are two long-term bond funds that look appealing right now.
First is the Vanguard Extended Duration Treasury ETF (EDV 0.17%). This fund has a rock-bottom 0.06% expense ratio and a 4.2% current yield, and it invests in an index of long-term (20- to 30-year) U.S. Treasury securities. The average maturity of bonds in its portfolio is 24.6 years, and the average yield to maturity is 4.5%.
Second, the Vanguard Long-Term Bond ETF (BLV 0.34%) is similar in nature, but with a broader focus. About half of this ETF’s assets are in long-term government bonds, like Treasuries, with the rest in investment-grade corporate bonds. This has the effect of a higher overall yield (about 4.7% currently). It has an even lower 0.04% expense ratio.
So, the Long-Term Bond ETF has a higher yield and a lower cost. The biggest drawback is that unlike the Treasury ETF, it has credit risk related to the companies that issue its bonds. This can make the ETF more volatile, especially in turbulent markets.
Why now?
The Federal Reserve is widely expected to start cutting rates at its meeting later this month, and to continue gradually lowering interest rates for at least the next year or so. Bond yields — especially long-term bonds like those owned by these ETFs — tend to move in the same direction as the federal funds rate. And since yield and price have an inverse relationship, lower prevailing bond yields could boost the prices of these ETFs.
In other words, these ETFs have portfolios of long-term bonds, many of which have today’s relatively high yield. As the yields on new long-term bonds get lower, the bonds already owned by these two ETFs become more valuable.
To illustrate this, take a look at how these two ETFs have performed during the rate-hike cycle in 2022 and 2023.
BLV data by YCharts.
While there’s no way to predict future performance (or Fed rate decisions) with complete accuracy, it’s likely that these ETFs will rise if rates fall significantly.
To be perfectly clear, both of these ETFs are great buy-and-hold investments for those who need more fixed-income exposure. Now could just be an excellent time to add them before rates start to fall.
How much fixed-income exposure should you have?
There’s no perfect answer to this question, but one popular guideline used by financial planners is to subtract your age from 110 to determine how much of your invested assets should be in stocks, with the rest in bonds. For example, I’m 42 years old, so this implies that I should have about 68% stock exposure and 32% of my money in fixed-income instruments like these two funds.
To be sure, I tend to use this as a guideline instead of a set-in-stone rule (I do not have exactly 32% of my portfolio in fixed income). But it is a good indicator of an age-appropriate mix of investments, so if you’re a little light on fixed-income exposure in your portfolio, some top-quality ETFs like these could be your solution.
Matt Frankel has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
