Bonds: Diversify Your Portfolio and Earn More | Vanguard (2024)

FAQs

Do bond funds diversify your portfolio? ›

The main difference is that individual bonds are specific loans, while bond funds are a mix of many loans. Bond funds offer more diversification because they spread your money across different loans, reducing risk. So, if you want more diversification, you might want to consider bond funds.

Bonds are a vital component of a well-balanced portfolio. Bonds produce higher returns than bank accounts, but risks remain relatively low for a diversified bond portfolio. Bonds in general, and government bonds in particular, provide diversification to stock portfolios and reduce losses.

Traditionally, the answer has been that bonds provide diversification and income. They zig when stocks zag, providing income for spending needs. In finance terms, bonds have “low correlation” levels to stocks, and adding them to a portfolio would help to reduce the overall portfolio risk.

Stocks offer an opportunity for higher long-term returns compared with bonds but come with greater risk. Bonds are generally more stable than stocks but have provided lower long-term returns.

It seems that Buffett has softened his stance. Berkshire Hathaway's portfolio includes a significant amount of short-term bonds, despite its leader's infamous public position. Speaking to CNBC's Becky Quick on Aug. 3, 2023, Buffett admitted: “Berkshire bought $10 billion in U.S. Treasurys last Monday.

All bonds carry some degree of "credit risk," or the risk that the bond issuer may default on one or more payments before the bond reaches maturity. In the event of a default, you may lose some or all of the income you were entitled to, and even some or all of principal amount invested.

The bond market is a wide field, with many different categories of assets. In general, you can expect a return of between 4% and 5% if you invest in this market, but it will range based on what you purchase and how long you hold those assets.

We suggest most investors first focus on "core" bonds, or high-quality bonds, like U.S. Treasuries, certificates of deposit, mortgage-backed securities, investment-grade corporate and municipal bonds, as well as Treasury Inflation-Protected Securities.

There are other asset classes such as real estate (property), commodities (natural resources, precious metals) and alternative investments. These asset classes usually have lower correlation to the stock market and as such can be effective to aid in diversification.

Is it a good idea to buy bonds now? ›

What to consider now. We suggest investors consider high-quality, intermediate- or long-term bond investments rather than sitting in cash or other short-term bond investments. With the Fed likely to cut rates soon, we don't want investors caught off guard when the yields on short-term investments likely decline as well ...

Build a portfolio with 80 percent stocks and 20 percent bonds. If you think you could tolerate a portfolio with 80 percent stocks and 20 percent bonds, build a portfolio with 70 percent stocks and 30 percent bonds.

There are two ways to make money on bonds: through interest payments and selling a bond for more than you paid. With most bonds, you'll get regular interest payments while you hold the bond. Most bonds have a fixed interest rate. Or, a fee you get to lend it.…

Historically, when stock prices rise and more people are buying to capitalize on that growth, bond prices typically fall on lower demand. Conversely, when stock prices fall, investors want to turn to traditionally lower-risk, lower-return investments such as bonds, and their demand and price tend to increase.

Historically, bonds have generated stronger risk-adjusted returns compared to stocks in the three years following Federal Reserve tightening cycles. After the past seven tightening cycles, bonds delivered 89% of the return of stocks with only 26% of the volatility with more consistency in their range of outcomes.

Diversification Isn't as Important with Bonds

To put it simply, diversification doesn't play as vital of a role in the bond markets as it does with stocks. It would mostly help with Default Risk, and that's pretty easy to avoid on our own.

Diversification Benefits of Bonds

This can help provide a level of stability to an investor's portfolio over time. For example, a portfolio that is totally invested in stocks will do well when market and economic conditions are favorable for stocks.

Buying individual bonds can provide increased control and transparency, but typically requires a greater commitment of time and financial resources. Investing in bond funds can make it easier to achieve broad diversification with a lower dollar commitment, but offers less control.

A bond ETF pays out the interest it receives on the bonds in its portfolio. So a bond ETF can be a good way to set up an income stream without having to worry about the maturity and redemption of individual bonds.