Why to Consider Longer-Term Bonds Now (2024)

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February 22, 2024 Collin Martin

Short-term bond yields are high currently, but with the Federal Reserve poised to cut interest rates investors may want to consider longer-term bonds or bond funds.

Why to Consider Longer-Term Bonds Now (1)

High-quality bond investments remain attractive. With yields on investment-grade-rated1 bonds still near 15-year highs,2 we believe investors should continue to consider intermediate- and longer-term bonds to lock in those high yields. By focusing more on short-term bond investments, investors likely will face reinvestment risk once the Federal Reserve begins to cut interest rates, as it is widely expected to do this year.

However, investors may be a bit reluctant to do that given how high short-term yields are. Why invest in a longer-term bond when it offers a lower yield than what you can earn in short-term investments like Treasury bills, short-term certificates of deposit (CDs), or money market funds? It's a question we're asked often, and if it's a question you're asking, you're likely not alone. The amount of money market fund assets has been rising sharply for years—their yields have risen sharply following the aggressive pace of Federal Reserve rate hikes that began nearly two years ago.

Money market fund assets have risen sharply over the last few years

Why to Consider Longer-Term Bonds Now (2)

Source: Bloomberg, Investment Company Institute (ICI), using weekly data as of 2/14/2024.

The ICI Money Market Funds Assets (MMFA Index) reflects total assets in money market funds for each week, and includes a total of the taxable and tax-exempt funds that report to the ICI.

Short-term bond yields, and the funds that hold them, are admittedly attractive today. Three- and six-month Treasury bill yields are above 5%, at levels not seen since before the global financial crisis of 2008-2009. Those high yields come with relatively low volatility and generally lower price declines versus securities with longer-term maturities when yields rise. If you own a three-month Treasury bill and other Treasury bill yields rise, the price of your three-month bill might not fall much because it matures so soon, and when it matures you can reinvest at a higher interest rate.

However, if you hold a five-year Treasury note and yields rise, you'll have to wait a long time for it to mature before you can take advantage of those higher yields. If you wanted to sell that note in the secondary market, it would likely be sold at a discount because the buyer would need the additional price appreciation to make up for that income gap. That's why intermediate- and long-term bond prices tend to be more volatile than short-term bond prices.

Treasury bill yields are highly sensitive to changes in the Federal Reserve's benchmark federal funds rate, which is set by the Federal Open Market Committee and is the rate at which U.S. banks lend money to each other overnight. When the federal funds rate rises, Treasury bill yields tend to follow. On the flip side, when the Fed is lowering rates, Treasury bill yields tend to fall. That opens up investors to reinvestment risk, or the risk that interest rates decline and maturing bond proceeds are re-invested at lower yields.

Treasury bill yields tend to track the federal funds rate

Why to Consider Longer-Term Bonds Now (3)

Source: Bloomberg, using weekly data as of 2/16/2024.

Federal Funds Target Rate - Upper Bound (FDTR Index) and US Generic Govt 3 Mth (USGG3M Index). Indexes are unmanaged, do not incur management fees, costs, and expenses and cannot be invested in directly. Past performance is no guarantee of future results.

The Fed has held rates steady since it raised rates to the 5.25% to 5.5% range in July 2023, but projections from the Fed as well as market expectations suggest that rate cuts are likely on the horizon. The median projection from Fed officials suggests that the Fed could cut rates to the 4.5% to 4.75% area this year. Market expectations, implied from the federal funds futures market, are just a bit more aggressive and are pricing in a year-end rate just below 4.5%.

With rate cuts likely coming soon, reinvestment risk is becoming much more real. Investors who have been holding short-term bond investments would likely be faced with lower yields when reinvesting their proceeds from maturing bonds.

Market expectations imply Fed rate cuts this year

Why to Consider Longer-Term Bonds Now (4)

Source: Bloomberg.

Market estimate of the Fed funds using Fed Funds Futures Implied Rate as of 2/16/2024. For illustrative purposes only. Futures and futures options trading involves substantial risk and is not suitable for all investors. Please read the Risk Disclosure Statement for Futures and Options prior to trading futures products.

Waiting for the Fed to cut rates before considering longer term bonds isn't our preferred approach. The bond market is forward-looking and long-term Treasury yields typically decline once investors believe that rate cuts are coming.

The chart below highlights this relationship—and highlights how different this cycle has been. Over the previous four rate hike cycles, the 10-year Treasury yield has tended to peak before the Fed hits its peak rate. Over the next 12 months, the 10-year Treasury yield declined.

This time has been different: The 10-year Treasury yield has been hovering in a range above where it was when the Fed last hiked in July 2023. We believe the historical relationship should hold and we expect the 10-year Treasury ultimately to decline modestly from current levels as growth and inflation slow. Investors who wait too long to consider locking in long-term yields may end up investing in lower yields than what are available today.

The 10-year Treasury yield historically has fallen after the Fed is done hiking rates

Why to Consider Longer-Term Bonds Now (5)

Source: Schwab Center for Financial Research with data from Bloomberg.

US Generic Govt 10 Yr (USGG10YR Index) and Federal Funds Target Rate - Upper Bound (FDTR Index). Change in 10-year Treasury yield using monthly data as of 2/16/2024, with the peak fed funds rate at month zero using the following months: February 1995, May 2000, June 2006, December 2018, and July 2023, which, for the purposes of this chart, is the expected last Fed rate hike of the cycle. A basis point is a measure of one one-hundredth of one percent (1 basis point is 0.01%). Indexes are unmanaged, do not incur management fees, costs, and expenses and cannot be invested in directly. Past performance is no guarantee of future results.

A quick look at short-term total returns supports the case for investing in longer-term bonds once the federal funds rate hits its peak. Over the last four rate hike cycles, intermediate-term bonds outperformed short-term bonds in the 12 months following the last Fed hike of each cycle.

The chart below focuses on 12-month total returns, which includes interest payments and price appreciation or depreciation. A total return is different from a yield—when you invest in a bond and hold it to maturity, your average annualized return will be pretty close to the starting yield of that bond. But in the short run, the price of bonds (or bond funds) can fluctuate depending on market conditions, as bond prices and yields generally move in opposite directions. The magnitude of those price fluctuations is generally tied to the bonds' time to maturity, with short-term bond prices generally having less interest rate sensitivity than bonds with longer maturities.

We compared the total returns of the 1-3 year subset of the Bloomberg U.S. Aggregate Index (short-term bonds) to those of the 5-7 and 7-10 year subsets to represent intermediate-term bonds. In each of the four previous rate-hike cycles, the intermediate-term indexes outperformed the short-term index, and often by a wide margin.

These total returns might not matter for investors who are holding a portfolio of bonds to maturity or hold bond funds for long periods of time. But even if bond total returns are unrealized they can provide more of a boost to a portfolio compared to a portfolio that holds just short-term bonds.

Total returns months after the federal funds rate hit its peak

Why to Consider Longer-Term Bonds Now (6)

Source: Bloomberg.

Source: Bloomberg. Twelve-month total returns for each period are as of month-end. Total return includes interest, capital gains, dividends, and distributions realized over a period.Past performance is no guarantee of future results.Indexes are unmanaged, do not incur management fees, costs, and expenses and cannot be invested in directly

Yields are still high for intermediate-term, high-quality bond investments. Focusing just on yield or income earned, investing in intermediate-term Treasuries hasn't been this attractive in more than 15 years.

Yes, the 10-year Treasury yield is off its recent peak of 5% from last October, but we don't expect it to get back to that level as inflation continues to trend lower. Hope is not an investment strategy. Rather than hope that the 10-year Treasury yield rises back to 5%, keep in mind that a yield over 4% hadn't been seen in years prior to that.

10-year Treasury yields are still near their 15-year highs

Why to Consider Longer-Term Bonds Now (7)

Source: Bloomberg, using weekly data as of 2/16/2024.

US Generic Govt 10 Yr (USGG10YR Index). Indexes are unmanaged, do not incur management fees, costs, and expenses and cannot be invested in directly. Past performance is no guarantee of future results.

Investors who are still concerned about the inverted yield curve and the idea of earning lower yields by investing in long-term bonds might want to consider investment-grade corporate bonds. Just like Treasuries, very short-term corporate bonds, like those maturing in less than a year, generally offer the highest yields. But beyond one year to maturity, the corporate bond yield curve is much flatter. By considering corporate bonds in the 7- to 10-year maturity range, the average yield is just 0.2% lower than very short-term corporates. With Treasuries, investors generally earn a full percentage point less by considering 7- to 10-year Treasuries rather than Treasury bills.

The investment-grade corporate bond curve is less inverted than Treasuries

Why to Consider Longer-Term Bonds Now (8)

Source: Bloomberg, as of 2/16/2024.

Columns represent the maturity-specified sub-indexes of the Bloomberg U.S. Corporate Bond Index and the Bloomberg U.S. Treasury Index. Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly. Past performance is no guarantee of future results.

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. We'd rather lock in high yields now than risk earning lower yields down the road.

For investors in or near retirement, locking in these high yields with high quality investments means that you likely don't need to invest as heavily in riskier investments to meet your goals.

1 The Moody's investment grade rating scale is Aaa, Aa, A, and Baa, and the sub-investment grade scale is Ba, B, Caa, Ca, and C. Standard and Poor's investment grade rating scale is AAA, AA, A, and BBB and the sub-investment-grade scale is BB, B, CCC, CC, and C. Ratings from AA to CCC may be modified by the addition of a plus (+) or minus (-) sign to show relative standing within the major rating categories. Fitch's investment-grade rating scale is AAA, AA, A, and BBB and the sub-investment-grade scale is BB, B, CCC, CC, and C.

2 Bloomberg US Corporate Bond Index average yield-to-worst of 5.4% as of 2/20/2024.

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Why to Consider Longer-Term Bonds Now (9)


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Why to Consider Longer-Term Bonds Now (10)

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Why to Consider Longer-Term Bonds Now (11)


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Why to Consider Longer-Term Bonds Now (2024)


Why are long term bonds better? ›

Inflation can also reduce the buying power of the dollars invested in a 30-year bond.  To offset these risks, all investors usually demand higher yields for longer-term maturities—meaning 30-year bonds usually pay higher returns than shorter-term bonds from an issuer or in any category.

Is now the time to buy longer term bonds? ›

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 ...

Why do people prefer short term bonds to longer terms bonds? ›

There are two primary reasons why long-term bonds are subject to greater interest rate risk than short-term bonds: There is a greater probability that interest rates will rise (and thus negatively affect a bond's market price) within a longer time period than within a shorter period.

What is considered a long-term bond? ›

Bonds can be classified according to their maturity, which is the date when the company has to pay back the principal to investors. Maturities can be short term (less than three years), medium term (four to 10 years), or long term (more than 10 years).

Why is long-term investing better? ›

Year on year, any returns on your investment get invested again and, just like that, your money could grow even further over time. With that in mind, having a long-term strategy could help you to benefit from the wonders of compound returns.

What are the advantages and disadvantages of long-term bonds? ›

Advantages include higher potential yields and income stability. However, Long-Term Bonds also come with risks, including interest rate risk, default risk, and reinvestment risk. These risks can lead to fluctuating bond prices and potential losses.

Is it a good idea to buy bonds now? ›

Answer: Now may be the perfect time to invest in bonds. Yields are at levels you could only dream of 15 years ago, so you'd be locking in substantial, regular income. And, of course, bonds act as a diversifier to your stock portfolio.

Should you buy long-term bonds when interest rates are high? ›

Should I only buy bonds when interest rates are high? There are advantages to purchasing bonds after interest rates have risen. Along with generating a larger income stream, such bonds may be subject to less interest rate risk, as there may be a reduced chance of rates moving significantly higher from current levels.

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.

Is it better to invest in long-term or short term bonds? ›

Bonds with shorter times to maturity are less sensitive to changes in interest rates than longer-term bonds, meaning investors won't suffer as much if rates head higher. Remember, interest rates and bond prices move in opposite directions, so as rates rise, bond prices fall and vice versa.

Are longer-term bonds more risky? ›

A long-term bond generally offers a maturity risk premium in the form of a higher built-in rate of return to compensate for the added risk of interest rate changes over time. The larger duration of longer-term securities means higher interest rate risk for those securities.

What are the disadvantages of long-term bonds? ›

  • Historically, bonds have provided lower long-term returns than stocks.
  • Bond prices fall when interest rates go up. Long-term bonds, especially, suffer from price fluctuations as interest rates rise and fall.

Why are long-term bonds riskier? ›

A bond may mature in a few months or in a few years. Maturity can also affect interest rate risk. The longer the bond's maturity, the greater the risk that the bond's value could be impacted by changing interest rates prior to maturity, which may have a negative effect on the price of the bond.

What are the features of a long-term bond? ›

Key features of bonds include face value, coupon rate and maturity date, while long-term notes include face value, interest rate and payment schedule. Face value for both is the amount paid to the holder at maturity, while coupon rate and interest rate refer to the annual interest paid to the holder.

Why invest in long-term Treasury bonds? ›

U.S. Treasury bonds are fixed-income securities. They're considered low-risk investments and are generally risk-free when held to maturity. That's because Treasury bonds are issued with the full faith and credit of the federal government.

Are long term bonds better if increased interest rates? ›

In the short run, rising interest rates may negatively affect the value of a bond portfolio. However, over the long run, rising interest rates can actually increase a bond portfolio's overall return. This is because money from maturing bonds can be reinvested into new bonds with higher yields.

Why do companies issue long term bonds? ›

Companies issue bonds with long maturities for the same reason they do a lot of things: There's a market demand, and the goal of any business is to profit from that demand. And, when it comes to 100-year bonds, a group of investors does exist that has shown a strong appetite for this sort of debt obligation.

How much is a $100 savings bond worth after 30 years? ›

How to get the most value from your savings bonds
Face ValuePurchase Amount30-Year Value (Purchased May 1990)
$50 Bond$100$207.36
$100 Bond$200$414.72
$500 Bond$400$1,036.80
$1,000 Bond$800$2,073.60

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