High inflation impacts all areas of life, from filling up at the pump to grabbing groceries from the store. Inflation is at 8.5% over the past 12 months, the highest level in over 40 years. While higher prices are an immediate sign of the times, inflation also impacts your purchasing power and investments.

Given the current economic situation, does it still make sense to invest in fixed-income vehicles like bonds? Many people use fixed-income securities to provide lower risk, but are they too conservative for the current market? 

Let’s see.

What’s a Bond?

A bond is a debt security. When you purchase a bond, you give the company or government you bought it from a loan. In return, they commit to paying back the loan with interest—sounds a lot like an IOU. The institutions use the money to fund various projects.

Bonds are a type of fixed income because, in most cases, the issuer pays the investor a set interest rate over a predetermined period. However, this is not always the case, as some bonds offer variable rates. In that case, the interest rate you receive will vary.

Many people think about bonds as a “safer” investment than stocks for several strong reasons. 

• Their value doesn’t fluctuate as much as stocks.
• Bonds offer guaranteed returns (subject to the financial health of the issuing company or institution).
• Investing in them brings diversification to your portfolio

Why Is Inflation Impacting Bonds?

Fixed-income securities like bonds can play an essential role in an investor’s portfolio because they provide a reliable and stable income stream. That reliability, however, also makes them prone to losing their purchasing power with accelerating inflation.

Here’s an example:

Inflation is rising, but interest rates remain the same. If you have a five-year bond that pays out $100 in interest every month, the amount of money you receive doesn’t change. But the value of that $100 continues to decrease over time because of inflation. 

The rate of interest typically remains the same on most bonds until they mature. The longer the bond takes to mature, the more future purchasing power you’re losing in a high-inflation environment.

Think of it this way: Bonds and interest rates have an inverse relationship: bond prices go down when interest rates go up, and vice versa.

Common Types of Bonds

Not all bonds are created equal. Some common types include U.S. Treasury bonds, savings bonds, I bonds, municipal bonds, and corporate bonds.

U.S. Treasury Bonds

U.S. Treasury bonds are backed by the federal government. They tend to be the safest types of bonds because they have the full faith and credit of the government behind them, but they often offer the lowest returns.

Savings Bonds & I Bonds

Many professionals are considering I bonds as a good tool for hedging inflation. I bonds are adjusted for inflation every six months and offer two types of payments: a fixed payment for 30 years and a variable payment adjusted for inflation.

I bonds have become increasingly popular with the current inflation acceleration. Over $11 billion in I bonds has been sold over the past six months, compared to around $1.2 billion in 2020 and 2021 over the same period.¹ 

Municipal Bonds

Municipal bonds, also known as “munis,” are issued by local government entities like the state, city, or county. The money raised by munis typically goes back into the community, like paving roads, building schools, or other projects that may benefit the public.

A significant benefit of municipal bonds is that they are typically exempt from federal income tax. Depending on your location, they may be exempt from state or local taxes as well.

Corporate Bonds

Just as you can buy stock in companies, you can also purchase corporate bonds. Unlike stocks, these bonds do not give you equity in the company. So the company’s profitability has no bearing on how much your bond earns in interest.

The upside? When the company’s performance is poor, and stock prices drop, your rates won’t be impacted.

The downside? When things are going well, and stock prices soar, you won’t benefit from the upswing.

Corporate bonds make up a significant portion of the bond market, but they tend to be the riskiest type of bonds. For example, if a company goes under, it may default on its bonds.

Can Bonds Bring Value to Your Portfolio in 2022?

Stocks and bonds tend to react differently to market conditions. In general, bonds can act as a buffer against volatility in stocks. They help create a diversified portfolio, which is imperative for long-term financial success.

Even amidst rising inflation, bonds can help mitigate risk, especially for those nearing retirement. They add stability to your portfolio and offer a regular stream of income.

3 Bond Strategies to Consider

Here are three bond strategies to consider as you consider incorporating bonds into your portfolio.

Buy Individual Bonds

You can build the fixed-income portion of your portfolio one piece at a time, buying each bond individually.

Invest in Bond Funds (ETFs)

Think of bond funds as the fixed-income version of stock mutual funds. Bond funds, or Bond ETFs, are a pooled investment vehicle that invests in various issuers, including U.S. Treasury bonds, corporate bonds, and munis. 

Build a Bond Ladder

A bond ladder strategy consists of multiple bonds that mature at regularly spaced intervals. As one bond reaches maturity, the investments roll over. This strategy creates equally spaced maturities and can help investors with the goal to attain higher average yields.

Are Bonds Right For You?

With today’s high inflation and low-interest rates, many investors question whether bonds are still the right move to add more stability to their portfolios. The answer depends on your unique circumstances, including timeline toward retirement, tolerance for risk, long-term goals, and more.

At Legacy Wealth Advisors, we help clients develop tailored portfolio strategies to help weather the market volatility and hedge inflation. Feel free to reach out to our team to learn more about what we can do for you.

Sources:

1What Are I Bonds? Everything You Need to Know to Earn Nearly 10% Interest

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