The Federal Reserve has cut interest rates by 175 basis points since 2024. During that time, the 10-year Treasury yield has stayed roughly unchanged.
Long-term yields don’t necessarily line up with where the Fed sets rates. But with inflation down sharply from its 2022 high and the U.S. economy showing signs of slowing, it wouldn’t be surprising to see yields move lower. So far, that hasn’t happened.
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That puts bond investors in a tough spot. Rates affect how much income bonds can produce. But the threat of higher inflation is also putting investment principal at risk. Investors could bet on a recessionary trend that pulls rates lower and rewards risk-taking. Or they can prepare for higher rates by keeping duration — how long it take to recoup a bond’s cost — short in order to protect principal.
The following four bond exchange-traded funds (ETFs) represent different ways to approach fixed-income investing. Given the volatility in the bond market right now, there’s no way of telling for sure which is the best choice.
But these ETFs would be among the best ways to invest depending on the direction you choose.
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If you’re looking for straightforward core bond market exposure, the Vanguard Total Bond Market ETF (NASDAQ: BND) is the choice.
It tracks the Bloomberg U.S. Aggregate Index, which invests in a combination of Treasury, corporate, and mortgage-backed securities. Government bonds currently account for nearly 70% of the portfolio. The fund would be more diversified with a better mix of credit types. But the intermediate-term duration, high credit quality, and 3.8% yield make it a solid option for income seekers simply wanting broad bond market coverage.
For investors who want income without the interest rate sensitivity, the Vanguard Short-Term Corporate Bond ETF (NASDAQ: VCSH) is worth considering.
Short-term corporate bonds are a good way to capture a 4.3% yield without a lot of the rate volatility risk or credit risk. Historically, it’s had about 40% less volatility than the Vanguard Total Bond Market ETF, which makes it ideal for investors who want to focus more on the income component.
If you believe rates will remain volatile, this ETF should mitigate a fair amount of that risk.
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With inflation rates hovering near 3% annually, the case for the iShares TIPS Bond ETF (NYSEMKT: TIP) is still relevant.
Inflation for housing, food, and healthcare was already stubbornly above the Fed’s target. The conflict in Iran adds another layer of risk to energy prices. Therefore, inflation protection is something investors might still want to consider even though we’re well past 2022’s peak.
Because the principal’s value adjusts with inflation rates, TIPS help to preserve purchasing power. And it generates a yield of 3.4%. If there’s a scenario where inflation continues to surprise to the upside, shareholders of this ETF will be protected.
If the Fed does cut rates at some point or the economy slows to the point where investors begin looking for safe assets, the Vanguard Intermediate-Term Treasury ETF (NASDAQ: VGIT) is set up well to benefit.
This ETF targets U.S. Treasuries with maturities of five-to-10 years, so it sits in that middle ground where investors can take advantage of a drop in rates without overexposure to risk. The primary risk with these bonds is that inflation continues pushing higher, and rate cuts get priced out altogether. This ETF yields 3.7%.
Which of these four to choose ultimately comes down to whether you want core bond exposure, income stability, inflation protection, or upside potential. All are solid choices but come with very different objectives.
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David Dierking has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard Total Bond Market ETF. The Motley Fool has a disclosure policy.
4 Bond ETFs Worth Considering as Rate Uncertainty Continues was originally published by The Motley Fool
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