What bonds are best when interest rates rise?
Short- and medium-term bonds are less sensitive to rate increases than longer-maturity bonds that lock into rising rates for longer time periods. However, short-term bonds provide less income earning potential than longer-term bonds.
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.
Technicals remain good
High yield bonds were not short of buyers in 2024 despite a notable rise in supply, and we think this can continue through most of 2025. Better quality high yield, we believe, should still generate investor appetite as declining interest rates encourage a search for yield.
There are U.S. Government Savings Bonds, called “I Bonds”, that are currently paying a 9.62% interest rate as of August 2022, you can continue to buy the bonds at that interest rate until October 2022, and then the rate resets.
| Company | Ticker | Industry |
|---|---|---|
| Costco Wholesale | COST | Retail (Specialty Stores) |
| Home Depot | HD | Retail (Home Improvement) |
| Ingersoll-Rand | IR | Industrial (Machinery) |
| PACCAR | PCAR | Industrial (Trucking/Construction/Machinery) |
What could 2024 bring? The yields investors can get are still high – always a good starting point. Meanwhile, inflation is finally coming down which means interest rates in large economies such as the US, Europe, and UK have likely peaked.
| ETF | Expense ratio | 30-day SEC yield |
|---|---|---|
| iShares 10-20 Year Treasury Bond ETF (TLH) | 0.15% | 4.7% |
| SPDR Portfolio Mortgage-Backed Bond ETF (SPMB) | 0.05% | 3.9% |
| BondBloxx CCC-Rated USD High Yield Corporate Bond ETF (XCCC) | 0.40% | 10.4% |
| BondBloxx Private Credit CLO ETF (PCMM) | 0.68% | N/A |
| Name | SEC 30-Day Yield | Total Return 1 Year |
|---|---|---|
| AB High Income Z AGDZX | 7.14% | 11.00% |
| AB High Yield ETF HYFI | 6.64% | 9.66% |
| Access Flex High Yield ProFund Inv FYAIX | — | 8.62% |
| Access Flex High Yield ProFund Svc FYASX | — | 7.40% |
Most bond investors are in it for the long haul, meaning for the term of the bond, but there are several good reasons for selling bonds before they mature. They include: Selling bonds because interest rates are about to increase, making your existing bonds less valuable.
The overall outlook for bonds in 2025 is notably positive. We anticipate an era where interest rates remain above inflation, helping investors achieve success in fixed income. Yields are attractive compared with those observed since the 2008 global financial crisis.
Do I pay taxes on I bonds?
Must I pay tax on what the bond earns? You choose whether to report each year's earnings or wait to report all the earnings when you get the money for the bond. If you use the money for qualified higher education expenses, you may not have to pay tax on the earnings.
| Denomination | Issue date | Value |
|---|---|---|
| $100 | October 1994 | $164.12 |
| $1,000 | October 1994 | $1,641.20 |
| $10,000 | October 1994 | $16,412.00 |
Pros: I bonds come with a high interest rate during inflationary periods, they're low-risk, and they help protect against inflation. Cons: Rates are variable, there's a lockup period and early withdrawal penalty, and there's a limit to how much you can invest.
- Stocks.
- Real Estate.
- Private Credit.
- Junk Bonds.
- Index Funds.
- Buying a Business.
- High-End Art or Other Collectables.
You can capitalize on higher rates by purchasing real estate and selling off unneeded assets. Short-term and floating-rate bonds are also suitable investments during rising rates as they reduce portfolio volatility. Hedge your bets by investing in inflation-proof investments and instruments with credit-based yields.
An expected boost from bond coupons
Sources: Vanguard calculations, based on data from Bloomberg as of June 30, 2021, and June 30, 2024. Bond yields at midyear 2021 were a paltry 0.25% for the 2-year and 1.45% for the 10-year, compared with midyear 2024 yields of 4.71% for the 2-year and 4.36% for the 10-year.
Bonds play a significant role in the global economy, and if the bond market declines or crashes, your investment account will likely feel it in some way. This can be especially concerning for investors with portfolios heavily weighted toward bonds, such as those in or near retirement.
| Fund | Expense Ratio | Trailing-12-month yield |
|---|---|---|
| Fidelity Conservative Income Bond Fund (FCNVX) | 0.25% | 5.1% |
| Fidelity Mortgage Securities Fund (FMSFX) | 0.44% | 3.9% |
| Fidelity Floating Rate High Income Fund (FFRHX) | 0.75% | 8.3% |
| Fidelity New Markets Income Fund (FNMIX) | 0.79% | 4.8% |
Orman specifically recommended buying three-, five- and seven-year Treasury notes. Following Orman's advice would stagger the maturity dates of your investments over several years, which would help reduce the risk stemming from interest rate fluctuations.
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What is the safest investment with the highest return?
- High-yield savings accounts.
- Certificates of deposit.
- U.S. Treasury bonds.
- Treasury inflation-protected securities.
- Investment-grade corporate bonds.
- Municipal bonds.
- Fixed annuities.
On a short-term basis, falling interest rates can boost the value of bonds in a portfolio and rising rates may hurt their value. However, over the long term, rising interest rates can actually increase a bond portfolio's return as the money from maturing bonds is reinvested in bonds with higher yields.
The 4.28% composite rate for I bonds issued from May 2024 through October 2024 applies for the first six months after the issue date. The composite rate combines a 1.30% fixed rate of return with the 2.96% annualized rate of inflation as measured by the Consumer Price Index for all Urban Consumers (CPI-U).
As of December 30, 2024, the major economy with the highest yield on 10-year government bonds was Turkey, with a yield of 27.38 percent.
Rising yields can create capital losses in the short term, but can set the stage for higher future returns. When interest rates are rising, you can purchase new bonds at higher yields. Over time the portfolio earns more income than it would have if interest rates had remained lower.
