2 Fixed Income ETFs to Consider Before the Fed Cuts Rates

The Federal Reserve looks set to cut interest rates for the first time since 2020 at its policy meeting later in September. Interest rates are expected to continue falling through 2025, and the median expectation at the time of writing is a total of 2.25 percentage points of cuts in the benchmark federal funds rate by the end of next year.

As we appear to be entering a falling rate environment, it might be a smart time to start thinking about strategically adding fixed income exposure to your portfolio. Here are two ETFs in particular that could worth a closer look and why now might be a great time to buy.

2 Fixed Income ETFs to Take a Closer Look at

We’ll get into the “why now” question in the next section, but here are two long-term bond funds that look attractive right now.

The first is Vanguard Extended Duration Treasury ETF (EDV 0.17%). This fund has an expense ratio of 0.06% and a current yield of 4.2% and invests in a long-term (20-30 year) US Treasury index. The average maturity of the bonds in its portfolio is 24.6 years and the average yield to maturity is 4.5%.

Secondly, 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, such as Treasuries, and the rest in investment-grade corporate bonds. This results in a higher overall yield (about 4.7% currently). It has an expense ratio of even less than 0.04%.

So the Long-Term Bond ETF has a higher yield and a lower cost. The biggest disadvantage is that, unlike the Treasury ETF, it has credit risk linked to the companies that issue their bonds. This can make the ETF more volatile, especially in turbulent markets.

why now

The Federal Reserve is expected to begin cutting rates at its meeting later this month and continue to gradually lower interest rates for at least the next year. Bond yields — especially long-term bonds like those held by these ETFs — tend to move in the same direction as the federal funds rate. And because yield and price have an inverse relationship, lower yields on the dominant bonds could drive up the prices of these ETFs.

In other words, these ETFs hold portfolios of long-term bonds, many of which have relatively high yields today. As new long-term bond yields get lower, the bonds already held by these two ETFs become more valuable.

To illustrate this, take a look at how these two ETFs performed during the 2022 and 2023 rate hike cycle.

BLV data by YCharts.

While there’s no way to predict future performance (or the Fed’s rate decisions) with complete accuracy, these ETFs are likely to rise if rates fall significantly.

To be perfectly clear, both ETFs are excellent buy-and-hold investments for those who need more exposure to fixed income. Now could be a great time to add them before rates start to fall.

How Much Fixed Income Exposure Should You Have?

It doesn’t exist perfect Answer this question, but a 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 and the rest in bonds. For example, I’m 42 years old, so that means I should have about 68% exposure to stocks and 32% of my money in fixed income instruments like these two funds.

To be safe, I tend to use this as a guideline instead of a hard and fast rule (I don’t have exactly 32% of my portfolio in fixed income). But it’s a good indicator of an age-appropriate investment mix, so if you’re a little light on fixed income exposure in your portfolio, some high-quality ETFs like these could be your solution.