2 Fixed Income ETFs to Consider Before the Fed Cuts Rates

The Federal Reserve appears set to cut interest rates for the first time since 2020 at its policy meeting later in September. Rates are expected to be cut through 2025, with the median expectation at the time of writing for a total cut of 2.25 percentage points in the benchmark federal funds rate by the end of next year.

Now that we appear to be entering a declining interest rate environment, it might be a smart time to think about strategically adding some fixed income exposure to your portfolio. Here are two ETFs in particular that are worth a closer look, and why now might be a good time to buy.

2 Fixed Income ETFs to Take a Closer Look At

We’ll dig deeper into the “why now” question in the next section, but here are two long-term bond funds that look attractive right now.

First of all, the Vanguard Extended Duration Treasury ETF (NYSEMKT: EDV). This fund has a rock-bottom 0.06% expense ratio and a 4.2% current yield, and it invests in an index of long-term (20- to 30-year) U.S. Treasury bonds. The average maturity of bonds in the portfolio is 24.6 years, and the average yield to maturity is 4.5%.

Secondly, the Vanguard Long Term Bond ETF (NYSEMKT: BLV) is similar in nature, but with a broader focus. About half of this ETF’s assets are in long-term government bonds, such as Treasuries, and the rest in investment-grade corporate bonds. This has the effect of a higher total yield (currently around 4.7%). It has an even lower expense ratio of 0.04%.

So the Long-Term Bond ETF has a higher yield and lower costs. The main disadvantage is that, unlike the Treasury ETF, it has a credit risk associated with the companies issuing the bonds. This can make the ETF more volatile, especially in turbulent markets.

Why now?

The Federal Reserve is widely expected to cut interest rates at its meeting later this month and continue to cut rates gradually for at least the next year or so. Bond yields, particularly long-term bonds like those in these ETFs, tend to move in the same direction as the federal funds rate. And since yields and prices are inversely related, lower prevailing bond yields could push up the prices of these ETFs.

In other words, these ETFs hold portfolios of long-term bonds, many of which have the current relatively high yields. As yields on new long-term bonds fall, the bonds already held by these two ETFs become more valuable.

To illustrate, consider the performance of these two ETFs during the 2022 and 2023 rate hike cycles.

While there’s no way to predict future performance (or the Fed’s rate decisions) with complete accuracy, it’s likely that these ETFs will rise if rates fall significantly.

The story continues

To be clear, both of these ETFs are great buy-and-hold investments for those who need more fixed income exposure. This could be an excellent time to add them before rates start to fall.

How much fixed income should you invest?

There is no perfect answer to this question, but a popular guideline that financial planners use is to subtract your age from 110 to determine how much of your invested capital should be in stocks, and the rest in bonds. For example, I am 42 years old, so this implies that I should have about 68% exposure to stocks and 32% of my money in fixed income instruments like these two funds.

Of course, I prefer to use this as a guideline rather than a hard and fast rule (I don’t have exactly 32% of my portfolio in fixed income). But it is a good indicator of an age-appropriate mix of investments, so if you’re a little light on fixed income in your portfolio, a few top-quality ETFs like this one could be your solution.

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2 Fixed-Income ETFs to Consider Before the Fed Cuts Rates was originally published by The Motley Fool