Are bonds safe during a recession? (2024)

Key points

  • A recession is a decline in economic activity over many months.
  • Bonds are debt securities companies and governments use to borrow money from investors.
  • Bonds have many advantages during a recession, but they also have risks.

If you’ve tuned in to the news lately, you’re probably at least a bit concerned about a recession on the horizon. You may also be wondering what you can invest in to keep your money safe.

One asset you may hear financial experts point to is bonds. Yes, some bonds are safe during recessions. Others, not so much.

Bonds, which are basically loans from investors to corporations and governments, provide regular cash flow and a decreased chance of losing your initial investment. But are they really safe during a recession? We spoke with two investment experts to find out.

The short answer is bonds tend to be less volatile than stocks and often perform better during recessions than other financial assets. However, they also come with their own set of risks, including default risk and interest rate risk.

What is a recession?

A recession is a period of economic decline and a normal part of the business cycle. According to the National Bureau of Economic Research, the organization that declares whether we’re in a recession, it’s “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.”

Kelly Kowalski, a chartered financial analyst and portfolio manager at MassMutual, says there are different schools of thought when it comes to what signifies a recession.

“A recession can be defined as two sequential quarters of economic contraction, but it is not a hard-and-fast rule,” Kowalski says.

During recessions, we are likely to see declines in gross domestic product (the value of goods and services produced in the country), increases in unemployment and reductions in business activity, including production and sales.

Recessions certainly aren’t fun, but they are a normal part of the business cycle. Most investors will live through more than one recession in their lifetimes and feel the impact on their portfolios.

What are bonds?

Think of a bond like a loan. It’s a security (a financial asset) issued by a corporation or government entity as a way of raising money. The investor lends the bond issuer a certain amount of money. The bond issuer makes interest payment to the investor during the bond term and repays the face value of the bond when it matures.

Bonds come in many different forms that can generally be broken into three categories.

1. Corporate bonds

Corporate bonds are issued by public and private corporations. Interest rates on corporate bonds are affected by the creditworthiness of the issuing company, meaning a top-notch company may pay less.

On the other hand, a high-yield bond — also known as a junk bond — may pay more. But because it’s issued by a company with a lower credit rating, there’s a higher risk it won’t pay.

2. Municipal bonds

Municipal bonds are issued by states, cities and counties and can be broken down further:

  • General obligation bonds. These bonds are unsecured debt government entities use for a variety of purposes. They are usually paid back with tax dollars the entities collect.
  • Revenue bonds. These bonds can be used to finance particular projects and are typically paid back using the revenue generated by those projects. If the project doesn’t generate the expected revenue, it could result in default.
  • Conduit bonds. These bonds are issued by municipalities on behalf of private entities like hospitals or universities. In this case, the conduit borrower, meaning the organization on whose behalf the bonds were issued, must pay back the municipality. If it fails to do so, the municipality may not be able to repay the bonds.

3. Treasury securities

Treasury securities are issued on behalf of the U.S. Treasury Department. They are backed by the full faith and credit of the U.S. government, making them the safest of all bond types. Treasury securities fall into a few different categories, depending on the term and nature of the bond.

One example is the I bond, which pays a rate that is linked to inflation. With inflation raging in 2022, the I bond garnered much attention from investors seeking refuge from the flagging stock market. While the rate has decreased since then — 6.89% through April compared to 9.62% for a time last year — the I bond may still be a good long-term inflation hedge.

Treasury bonds guide: How and when to buy

Are bonds a safe investment during a recession?

Many people consider bonds to be safe alternatives to stocks. Considering recessions are often accompanied by stock market declines, it makes sense investors would turn to bonds.

While it’s true bonds are less volatile and tend to outperform stocks during a recession, that doesn’t necessarily make them safe investments or mean you should invest strictly in bonds during a recession.

As we mentioned above, there are many types of bonds. And while some — namely U.S. Treasury securities — are practically risk-free, others carry risks.

Whether you should invest in bonds depends less on the state of the economy and more on your investment goals, says Robert Johnson, a professor of finance at the Heider College of Business at Creighton University. He recommends creating an investment policy statement, or IPS, where you set investment objectives and an investment strategy.

“The whole point of an IPS is to guide you through changing market conditions,” Johnson says. “It should not be changed as a result of economic or market fluctuations. It only needs to be revised when your individual circumstances change.”

Why might bonds be a safe investment?

Bonds’ reputation as safer investments isn’t entirely unwarranted. They have benefits investors may find especially attractive during a recession.

Bonds tend to be less volatile and generally outperform stocks during a recession

A bond is essentially a loan. Whether you get your investment back depends on the issuing entity repaying that loan.

“Bonds, such as Treasurys, corporate bonds and municipal bonds, have contractual cash flows,” Kowalski says. “Compared to stocks, there is a much lower likelihood of losing your initial investment because the issuer of the bond agrees to pay interest and principal back at specific dates.”

The chances of default are even lower when you’re talking about investment-grade bonds or bonds issued by the federal government.

Bonds provide a regular source of income

Many long-term bonds make interest payments to investors every six months. At a time when your stock investments may be losing value and dividends may be falling, that interest income can be especially attractive.

Risks

While bonds have advantages, there are also risks to consider.

Bonds don’t completely eliminate the chances of losing your money

A bond is a loan, and bond issuers can default on their loans just like any other borrower can.

“Investors in corporate bonds, particularly junk bonds, should be concerned with default risk,” Johnson says. “And when the economy enters a recession, the likelihood of corporate defaults rises.”

Rising interest rates are bad news for existing bondholders

As a bond investor, it’s easy to see rising interest rates as a benefit. But that’s the case only for people who are considering investing in bonds, not those who already have.

“For existing bondholders, rising interest rates are bad news,” Johnson says. “As rates rise, the value of already-issued bonds falls.”

Bonds may have lower returns than stocks

You may be able to protect some of your money by investing in bonds during a recession. But the stock market tends to be forward-looking, meaning it will likely start rebounding before the recession ends. When that happens, you run the risk of having your money tied up in bonds rather than taking advantage of potential stock market growth.

That’s not to say that you shouldn’t invest in bonds at all during a recession. But it does support Johnson’s point that your investment strategy shouldn’t necessarily change based on whether the economy is in a recession.

Frequently asked questions (FAQs)

Yes, you can lose money investing in bonds if the bond issuer defaults on the loan or if you sell the bond for less than you bought it for.

Even if the stock market crashes, you aren’t likely to see your bond investments take large hits. However, businesses that have been hard hit by the crash may have a difficult time repaying their bonds.

There are many bond types, so rather than looking for an alternative to bonds, it might make more sense to choose the bond that best fits your investment goals.

Are bonds safe during a recession? (2024)

FAQs

Are bonds safe during a recession? ›

Do Bonds Lose Money in a Recession? Bonds can perform well in a recession as investors tend to flock to bonds rather than stocks in times of economic downturns. This is because stocks are riskier as they are more volatile when markets are not doing well.

What happens to bonds during a recession? ›

Bonds, particularly government bonds, are often seen as safer investments during recessions. When the economy is in a downturn, investors may shift their portfolios towards bonds as a "flight to safety" to protect their capital. This shift increases the demand for bonds, raising their price but reducing their yield.

Where is the safest place to put money in a recession? ›

Still, here are seven types of investments that could position your portfolio for resilience if recession is on your mind:
  • Defensive sector stocks and funds.
  • Dividend-paying large-cap stocks.
  • Government bonds and top-rated corporate bonds.
  • Treasury bonds.
  • Gold.
  • Real estate.
  • Cash and cash equivalents.
Nov 30, 2023

Are bonds safe if the market crashes? ›

Even if the stock market crashes, you aren't likely to see your bond investments take large hits. However, businesses that have been hard hit by the crash may have a difficult time repaying their bonds.

Are Treasury bonds recession proof? ›

Specifically, investors often move money to long-term Treasuries when they are concerned about a recession. Such bonds are desirable under those circumstances because they offer risk-free returns over an extended time period regardless of the economic environment.

What is the best asset to hold during a recession? ›

Cash, large-cap stocks and gold can be good investments during a recession. Stocks that tend to fluctuate with the economy and cryptocurrencies can be unstable during a recession.

Do you buy or sell bonds in a recession? ›

As investors start to anticipate a recession, they may flee to the relative safety of bonds. Typically, they're expecting the Federal Reserve to lower interest rates, helping to keep bond prices up. So going into a recession may be an attractive time to purchase bonds if rates haven't yet fallen.

What is the best thing to do with cash during a recession? ›

Where is your money safest during a recession? Many investors turn to conservative asset classes such as bonds during recessionary periods. Mutual funds may also be a useful area to consider, and so may established, large-cap companies with strong balance sheets and cash flow.

Are CDs safe if the market crashes? ›

Are CDs safe if the market crashes? Putting your money in a CD doesn't involve putting your money in the stock market. Instead, it's in a financial institution, like a bank or credit union. So, in the event of a market crash, your CD account will not be impacted or lose value.

Where not to invest during a recession? ›

What investments should you avoid during a recession?
  • High-yield bonds. Your first instinct might be to let go of all your stocks and move into bonds, but high-yield bonds can be particularly risky during a recession. ...
  • Stocks of highly-leveraged companies. ...
  • Consumer discretionary companies. ...
  • Other speculative assets.
May 10, 2023

Are bonds a good investment in 2024? ›

Starting yields, potential rate cuts and a return to contrasting performance for stocks and bonds could mean an attractive environment for fixed income in 2024.

What is the outlook for bond funds in 2024? ›

Key central bank rates and bond yields remain high globally and are likely to remain elevated well into 2024 before retreating. Further, the chance of higher policy rates from here is slim; the potential for rates to decline is much higher.

Are bonds safer than stocks right now? ›

U.S. Treasury bonds are generally more stable than stocks in the short term, but this lower risk typically translates to lower returns, as noted above. Treasury securities, such as government bonds, notes and bills, are virtually risk-free, as the U.S. government backs these instruments.

Are Treasury bonds safe if banks fail? ›

Bonds are considered a low-risk investment because the federal government fully backs them, not banks. They tend to be long-term investments and are considered a great way to diversify your investment portfolio.

Should I invest in bonds or CDs? ›

After weighing your timeline, tolerance to risk and goals, you'll likely know whether CDs or bonds are right for you. CDs are usually best for investors looking for a safe, shorter-term investment. Bonds are typically longer, higher-risk investments that deliver greater returns and a predictable income.

How to profit from a recession? ›

What businesses are profitable in a recession? Many investors turn to stocks in companies that sell consumer staples like health care, food and beverages, and personal hygiene products. These businesses typically remain profitable during recessions and their share prices tend to better resist stock market sell-offs.

Should I take my money out of the bank before a recession? ›

Your money is safe in a bank, even during an economic decline like a recession. Up to $250,000 per depositor, per account ownership category, is protected by the FDIC or NCUA at a federally insured financial institution.

Should you keep cash at home during a recession? ›

During economic downturns you want to have as much cash on hand as possible. If it is not absolutely necessary, it may be best to delay any big-ticket purchases. Big purchases, such as a car or house, typically require you to either put down a large lump sum of cash or have a hefty ongoing payment.

How do you not lose money in a recession? ›

Build up your emergency fund, pay off your high interest debt, do what you can to live within your means, diversify your investments, invest for the long term, be honest with yourself about your risk tolerance, and keep an eye on your credit score.

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