The clock is running out on those 5% yields on cash, and investors who stay in those instruments risk seeing their income take a tumble as rates come down. At the conclusion of the Federal Reserve’s July meeting, Chairman Jerome Powell indicated that a September rate cut is a possibility, provided inflation data continues to cool. Short-term instruments, such as money market funds and the interest paid in your high-yield savings account – topping 5% at some banks – will see their income drop once the Fed cuts rates. The good news is that investors can start moving some of that cash toward longer-dated bonds in a bid to lock in today’s higher yields and benefit from price appreciation as rates come down. Bond yields and prices move inversely to each other. “It favors longer-term strategies: You can have some duration and still get pretty strong yield, so the income component is pretty attractive relative to where it’s been for the past two decades,” said Paul Olmsted, senior manager research analyst, fixed income, at Morningstar. Duration is a measurement of a bond’s price sensitivity to interest rate fluctuations, and bonds with longer maturities tend to have greater duration. Here’s where investors can look as they reposition out of cash and into fixed income. Core bond funds Investors looking to tiptoe out of cash and collect solid yields may want to consider core bond funds. The category held up well during the 2008 and 2020 recessions , providing investors stability as stocks went reeling. These funds may deserve another look after this latest bout of market volatility, Olmsted said. “When you have a market where you have mixed signals, diversification is your friend,” he said. Core bond funds offer investors a combination of Treasurys, mortgage-backed securities, asset-backed securities and corporate bonds. They also tend to have an intermediate duration of roughly four to six years, rather than being concentrated in the short end of the yield curve. “It’s owning investment-grade corporates, high quality mortgage-backed, asset backed securities and things that don’t always move in tandem,” said Olmsted. “It helps to have some diversification in these periods, and the yield advantage helps when you look at this type of environment.” Vanguard’s Core Bond Fund (VCORX) , for instance, has a 30-day SEC yield of 4.47% and an expense ratio of 0.20%. The fund’s duration is 5.9 years. There is also the Fidelity Intermediate Bond Fund (FTHRX) , which has a 30-day SEC yield of 4.32% as of Aug. 6 , as well as an expense ratio of 0.45%. Its duration is about 3.8 years. For investors who want to get a little more yield from core bond funds, there is the “core plus” category. “The ‘plus’ comes from those products having a little more exposure to higher yielding and somewhat riskier segments of the bond market, including high yield bonds,” Jeff Johnson, Vanguard’s head of fixed income product, said. This can add another 20 basis points to investors’ yield, but it comes with a little more exposure to a potentially weakening economic environment, he added. One basis point is equal to one one-hundredth of a percent. To that effect, Vanguard’s Core-Plus Bond Fund (VCPIX) has a 30-day SEC yield of 4.66%, and an expense ratio of 0.3%. Roughly 8.9% of its allocation is in BB-rated bonds, while 2.6% is earmarked toward B-rated issues. Bonds rated BB+ and below by Standard & Poor’s are deemed “speculative grade.” Ramping up on munis Another way for investors – especially those who are in high income tax brackets – to ramp up on duration and get a little more yield is to buy municipal bonds. Muni bonds spin off income that’s free of federal taxes, and if investors reside in the same state that’s issuing the bond, the income may also be free of state levies. Though muni bonds’ yields generally aren’t as high as their corporate counterparts, their tax-exempt status makes them especially valuable to high income investors. With a tax-free yield of 3%, an investor in the 32% federal income tax bracket would have to find a comparable taxable bond yielding 4.41%. “Clients want to hang out in the front end of the yield curve, and it feels like the Fed cutting is what will create the impetus to go ahead and move,” said Sean Carney, chief investment officer of municipal bond funds and head of municipal strategy at BlackRock. “Munis continue to do the same things you want them to do: They are low volatility, give off attractive yield, defaults continue to be low, and upgrades are outpacing downgrades,” he said. A barbell strategy using two ETFs – in this case, BlackRock’s Short Maturity Municipal Bond ETF (MEAR) and High Yield Muni Income Bond ETF (HYMU) – may offer a combination of duration and yield, Carney said. “We think of that as a way to be active in the market and barbelled from a yield curve perspective and credit perspective,” he added.
