Like all markets, bonds fluctuate. Your returns will be based on what you hold, when you buy it, tax treatment and other factors. While many choose to diversify their portfolios across stocks, bonds and other assets, an all-bond portfolio may allow for more predictability and income generation. You can also diversify an all-bond portfolio with different products.
Despite the various ways to set up a portfolio, you can estimate a return on an all-bond portfolio by looking at current yields. For example, a triple-A rated corporate bond you can expect a yield of about 5.6%. Or, if you purchase a ten-year Treasury bond, you can expect a yield of about 4.45%.
That’s just the tip of the iceberg, though.
A financial advisor can help you determine the best way to set up an income-generating portfolio for your goals.
Why Invest in Bonds?
Bonds provide two main benefits for your portfolio: security and income.
A bond-based portfolio is generally secure. With a bond you aren’t an investor, you’re a lender – so you only lose money if the borrower defaults. There is still some risk here, but with creditworthy borrowers it’s low. Historically, for example, well-rated corporate bonds default between 0% and 0.38% of the time.
These portfolios are generally also income-generating, meaning they issue regular payments while you hold them. Unlike regular stocks, you don’t have to sell off bonds in order to convert them to cash. You receive cash payments periodically, typically either every every six months, creating a stream of income that can potentially last for decades depending on the details of your specific bonds.
The downside to all of this is that bonds tend to provide a low return compared to the rest of the market. Riskier assets like stocks and real estate may often outpace the returns of a bond portfolio.
Talk to a financial advisor to determine the best asset allocation for you.
Three Types of Bonds
Setting aside foreign investment, there are three types of bonds:
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Corporate bonds: Notes issued by a private company
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Treasury bonds: Notes issued by the U.S. government
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Municipal bonds: Notes issued by local governments
Creditworthiness is most important with corporate bonds. These can have a wide range of interest rates determined by an individual company’s credit, assets and reputation, and have the most risk associated with them since companies could theoretically default.
Two Types of Bond Returns
There are two main types of return for bonds: Yield and Capital Gains.
Yield is based on the interest payments you receive for holding the bond. It is the ratio of interest you receive compared with what you paid for the bond. For example, if you receive payments of $50 per year on a bond for which you paid $1,000 for the yield would be 5%.
When you purchase a bond directly from the issuer, the yield and the interest rate are the same. When you purchase a bond from another investor, the yield can differ from the interest if you did not pay face value for the note.
Capital gains may apply if you sell the bond to another investor at a premium. In our example above, say, if you were to sell the bond to someone else for $1,100, your market return would be 10% and may be subject to capital gains tax.
Note that the tax treatment on the bond returns varies depending on the circumstances. Talk to a financial advisor today to ensure you have the right tax mitigation strategy.
Average Return On Bonds
Measuring the return on a bond is not like measuring the return of a market asset. The yield on your asset will not fluctuate over time. It is fixed at the time of purchase. If you buy a bond at 6%, it will remain at 6% regardless of market activity. This reduces the value of long-term averages for investment decisions.
At the same time, average return for bonds is an extremely broad subject. Bonds will have different yields and market returns based on the duration of the note, the issuer, the rate structure and more. A 10-year Treasury bond, for example, will have an entirely different profile from a 30-year BBB corporate bond.
However there are a few broad averages we can pull.
Overall Portfolio Return – 5.33%
If you build a portfolio entirely out of bonds, investing in different types over time, historically this would generate a 5.33% average return. This represents the return on a managed portfolio that combines interest and market returns.
Bond Index Return – Between 2.52% and 11.85%
The bond market may be accessed in index form, with individual investments reflecting the value of a variety of assets. Among bond indexes include:
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S&P 500 Bond Index: 10-year running average of 2.52%
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Vanguard bond market index fund: 10-year average of 9.06%
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Blackrock Aggregate Bond Index Fund: 10-year average of 7.93%
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Bloomberg US Aggregate Bond Index: 10-year average of 11.85%
Average Return on Corporate Bonds – Between 4% and 5%
At time of writing, you can buy corporate bonds for an average yield of 5.61%. This would be your interest-based return if you built a 100% bond portfolio overnight.
In the long run, if you were to only invest in AAA corporate bonds over time, you can expect a modern yield between 4% and 5%. Historic rates have been higher, sometimes up to 15%, leading to a 30-year average of 6.1%. However this is likely misleading, as corporate bonds have only averaged a yield above 6.1% once in the past 20 years.
Discuss strategies to obtain the best return rates with a financial advisor.
Average Treasury Bond Yield – Between 3% and 4%
Perhaps the most representative asset offered by the Treasury is a 10-year bond. If you purchase a 10-year Treasury at time of writing, you could expect a yield of about 4.45%. Based on yields over the past 20 years, you can expect average interest payments of between 3% and 4%.
Average Return on Municipal Bonds – 2.12%
The Bloomberg Municipal Bond Index is generally considered to be the municipal bond benchmark. Over the past 10 years it has averaged a 2.12% average annual return, although that figure has fluctuated from a 9.6% high to a -2.6% loss. This is consistent with the S&P 500 Municipal Bond Index, which has a 2.6% 10 year return. Remember, a financial advisor guide you through bond portfolios.
The Bottom Line
The bond market is a wide field, with many different categories of assets. In general, you can expect a return of between 4% and 5% if you invest in this market, but it will range based on what you purchase and how long you hold those assets.
Bond Market Tips
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Bond funds aren’t necessarily as well known or as common as stock market index funds, but they can be an excellent way to get into this market. So it’s worth knowing how to find and invest in these assets.
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A financial advisor can help you build a comprehensive retirement plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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Source: finance.yahoo.com