In this article, we will discuss investment opportunities in bonds in a bear market and how to protect against market declines. We will review some investments to consider and some investments to avoid in the event of a market downturn.
Active Investment Funds
Many investors prefer index funds due to their low costs and expected returns. However, in the case of a bond market decline, it is essential to consider active investment funds where managers can adjust their portfolios to reduce risks and capitalize on available opportunities.
Unconstrained Bond Funds
Unconstrained bond funds are considered the next step after active management, as managers can invest in any market they desire in terms of credit quality, maturities, and geographies. This allows investors broader opportunities to avoid market downturns.
Variable Rate Bonds and International Bonds
Instead of paying a fixed interest rate, the yields on these bonds fluctuate with prevailing interest rates. Although they are not perfect protection against poor market performance, variable rate bonds are expected to perform better than fixed rate investments in a declining market.
Since international economies may not be affected by the same set of conditions impacting the United States, they may not perform as poorly in a bear market. However, investors should consult their financial advisors before investing in international bonds, as they involve currency and sovereign risks.
Individual Bonds
Unlike bond funds, individual bonds have a specific maturity date. This means that regardless of what happens in the bond market, the investor is guaranteed to receive their invested capital unless the issuer defaults on their debt.
Bond funds are likely to experience ongoing valuation pressure in a rising interest rate environment, whereas individual bonds held by investors until maturity will retain their par value. If interest rates are rising, prices will fall, allowing the opportunity to buy more bonds and hold them until maturity.
Short-Term Bonds
Short-term bonds are not particularly exciting and do not offer much yield. However, they are very conservative investments and are unlikely to incur significant losses in a bear market if the investor is concerned about interest rate risks.
Although short-term bonds may not yield profits in a bear market, they are better at preserving capital and preventing large losses from investing in funds reliant on bond yields in a rising interest rate environment.
Bonds Instead of Alternative Investments
During periods of low interest rates, investments in dividend-paying stocks and hybrid investments such as preferred stocks and convertible bonds were common choices. However, the best option is to avoid the risks associated with the stock market—even in conservative investments—unless you can afford short-term losses.
Avoid High-Risk Assets
If a gradual decline in bond prices is expected over an extended period, high-grade investment-grade bonds and high-yield bonds may perform better due to the higher yields they offer.
However, if the bond market experiences a rapid sell-off, these assets are likely to perform very poorly. Investors should approach the market with a strategy suitable for any potential scenario.
Funds in these areas can be considered, but more conservative options should be sought, such as short-term high-yield bond funds that offer a mix of good yield and lower risks from interest rates, or somewhat protected target maturity funds due to their fixed maturity dates.
Conclusion
Instead of
Taking on more risks to achieve additional returns in the bond market during bear periods, it is always best to follow a more conservative approach to protect capital. While a bear market is not a certainty, the odds suggest that weak future returns outweigh the chances of returning to a high-yield environment like that experienced from 2010 to 2012. Investors, especially those approaching retirement age, should consider ways to protect their portfolios from a dangerous financial scenario.
Source: https://www.thebalancemoney.com/what-to-own-and-what-to-avoid-in-a-bond-bear-market-417036
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