Avoid This Big Bond Investing Mistake

“We’re all subject to all these biases,” says Jones, “and it’s pretty easy to get caught up in all of these things, whether you tend to become very fearful or overly aggressive.” She says focusing on the coupon element of a bond portfolio — the annual interest payment, which tends to be predictable over the long term — and using set-it-and-forget-it strategies like bond ladders can help remove human error from the equation in an uncertain market.

Bonds are at it again

For Jones, the recent stock market selloff had one important aspect: bonds moved in the opposite direction. “The good news is that bonds are behaving as they should,” she explains. When stocks tumbled on fears of a growth slowdown and tech stocks lost momentum, bonds surged. The Morningstar US Market Index is down 2.27% over the past month, while the Morningstar US Core Bond Index is up 1.75%.

“That’s exactly what (bonds) are supposed to do in a situation like this,” Jones says. “It should be a safe haven where investors go when there is a high degree of uncertainty.” That’s a big change from 2022, when bonds and stocks crashed together.

Bond yields have fallen, but opportunities remain

The less great news, Jones says, is that we should expect lower yields in the coming months as the Federal Reserve eases policy. That means the “perfect time” to lock in higher yields at the longer end of the curve has likely passed. “The economy is slowing, inflation is coming down. We expect the Fed to start cutting rates in September. And all that means bond yields should go down,” she explains. “The opportunity set that we saw a month, two months, six months ago to lock in 5% (yields) is much diminished.”

That said, Jones believes investors still have room to find higher yields on the order of 4.5% or even 5.0% outside of the Treasury market. Overall, yields are still “not too bad,” she says, “when you look forward in a falling rate environment. I think it can still make sense to people.” It indicates investment-grade corporate bonds and mortgage-backed securities. And since bond prices tend to rise as yields fall, investors can expect a slightly higher return on their bond holdings in the meantime.

Focus on the coupon

However, this does not mean that long-term investors should watch for price appreciation. Between lower yields and the potential for higher volatility, Jones says it’s important to maintain a long-term view rather than worry about price fluctuations. Historically, most of the return investors see from bonds comes from coupon payments, not price appreciation.

Jones says the iShares Core US Aggregate Bond ETF (AGG), often used as a proxy for the bond market as a whole, is up about 3% this year. This is true even though yields and prices are essentially flat for the year (with a healthy dose of volatility in between). “You have a positive return because you earn those coupons,” she says.

Why Bond Market Timing Won’t Work

Jones encourages investors to think of their fixed-income allocations as just that—income—as well as a diversification and capital preservation strategy, rather than getting caught up in the day-to-day action of the bond market. “Everyone is always trying to time the market, which we don’t suggest,” she says. This impulse can lead to a common and costly pitfall. “It’s hard,” Jones says, for an investor to watch a bond fund’s net asset value (the aggregate price of each share) move up and down. “People get really nervous and tend to do the wrong thing,” she says. “They sell when it’s down.”

Selling a bond fund at a low level means losing profits, Jones explains: “The bond manager will most likely get rid of low-coupon bonds and buy higher-coupon bonds, they may bear some tax losses and so you” I’m stuck at a loss with no upside.”

The antidote? “Stick to your time frame. Don’t buy a five- or 10-year bond fund and sell it in six months because it’s down.” Investors who hold bonds to maturity can expect to earn close to the coupon yield, but investors who sell early cannot.

Consider Bond Stairs

While peak returns may be in the rearview mirror, Jones says it’s never a bad time to keep an eye on your portfolio and rebalance if necessary. For investors looking to add more fixed income to their portfolios, she points to bond ladders — a portfolio of bonds that mature at regular intervals. “We always like bond ladders because it gets people out of the business of trying to time the market,” says Jones. “If you do a bond ladder and just reinvest, you should be fine over time.”

This article originally appeared on our US homepage and has been republished for UK audiences. The author(s) do not own shares in any of the securities mentioned in this article. Learn about Morningstar’s editorial policies