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Don’t think bonds deserve a place in your portfolio? What if I could show you how to get twice the dividend yield on half the risk compared to stocks. Better still, what if by adding a bond ETF to your portfolio along with stocks and real estate, you could have beat the market this year with less volatility?
That’s the power of bonds. They’re not going to make your rich but will protect you and provide income when stocks fall apart. Even on higher interest rates this year, my favorite bond fund has provided a dividend yield more than twice what you get from stocks!
In this video, I’ll share the five best bond funds to watch and the one every investor should be buying. It’s the eighth in our Just One Stock series, if you could only invest in one stock in different themes, which should it be! Going to cover all the strategies here from value to growth, tech stocks and by the end of the series, you’ll have a portfolio of the very BEST stocks to buy!
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Up until now, we’ve spent almost the entire series on stocks and that’s going to be the biggest part of your portfolio but combining those with a bond fund and the real estate we talked about in our last video and you get higher returns at less risk!
Let’s start with a few of the bond ETFs I’m watching before I show you what to look for in these, how to know which is the best for your portfolio and how much to invest.
5 Best Bond Funds to Watch
Our first bond fund is the SPDR High Yield Bond ETF, ticker, SPHY, and is going to be one of the riskier funds but with a great yield of 5.6%
The fund invests in nearly 2,000 individual bonds, all in that non-investment grade rating category that offers the highest yields. Here you’ve got a lot of consumer companies, telecoms and energy names but no bond is more than a third of a percent of the portfolio.
Now because these are less highly-rated companies in credit rankings.
Maybe a quick refresher on what bonds is and why they are so much safer than stocks. Bonds are a loan to the company. They pay interest twice a year and then return the loan value at the end of the bond’s life. That means companies legally have to pay back their bonds plus the interest. Stockholders only get a return and dividends as long as the company can produce profits and stay in business but bondholders have that higher right to assets. The interest rate or yield on bonds is largely determined by the company’s credit rating, a scale of how financially stable the company’s financials are and how likely it is to pay the debt back. Higher risk equals a lower rating and a higher interest rate on the bonds.
OK back to the high yield bond ETF, and because these are less highly-rated companies in credit ratings, the bond values are going to rise and fall more with the stock market and the economy. As the economy weakens, it’s more likely that more bonds default so you do see this one jump around more than other bond funds.
That said, the volatility is still less than half the stock market. Here we see that standard deviation of almost 21% for stocks and just 8.8% for the SPHY fund.
I won’t go into the math behind the standard deviation because it’s only interesting to nerds like myself but think of it as your sleep-at-night measure, how much an investment jumps around when stocks crash. For example, the S&P 500 has a tendency to rise or fall 20% in any given year…great when it’s rising but not so much when it crashes. By comparison, that High Yield Bond ETF only rises or falls about 9% on average, much less volatile and is able to produce a dividend yield almost four-times what you get with stocks…that’s an investment you just can’t ignore.
You can see that lower volatility in the price chart here. While the SPHY and the broader stock market have produced about the same return this year, the bond fund did it for a much smoother ride. You didn’t have to watch your portfolio crash lower and wonder if you could still reach your goals.
So, the high yield bond ETF is going to be better for investors that can take a little more risk but still want the safety of bonds for a part of their portfolio. You’ll get that higher dividend and protection from a crash.
And I know bonds haven’t lived up to the safety they’re supposed to provide this year and a lot of investors are still skeptical. With rising interest rates, bonds got slaughtered in the first half of the year. Here you see the Core Aggregate Bond Fund, ticker AGG, plunged 10% in just six months, unheard of for fixed income.
In fact, it’s the worst first half performance since 1788…
But if you look back on that chart, bonds still protected your portfolio. Not only did the bond fund suffer half the losses compared to stocks, but it was a much smoother ride instead of crashing lower.
Fortunately, the five bond funds I’ll highlight today did even better than that and better still…they outperformed while paying more than twice the dividend yield and at half the risk of stocks. Here we see the standard deviation for the stock market versus all five funds along with the dividend yields. With the exception of one fund, all of them are less than half as volatile as the market for great protection and cash flow.
I want to get back to our list so I’ll show you what to look for and how much to invest in bonds later in the video.
The VanEck Fallen Angel High Yield Bond ETF, ticker ANGL, is another with a little higher risk but a strong 4.3% dividend and good potential upside.
The fund invests in bonds that were issued with an investment-grade rating, so a strong financial rating, but that have been downgraded into high-yield. This is usually on slightly weakening financials or if the company adds more debt but 93% of the bonds in the fund are in the first two risk ratings just below investment-grade, so still fairly safe investments.
What happens is when these fallen angels get downgraded, the price of the bond comes down but it’s still paying that coupon so the interest rate goes up. Since they’re still solid companies, the default rate is low and this group of bonds has outperformed the broader high-yield index in 11 of the last 15 years.
The fund itself has produced an 8.4% annualized return since 2012 which is really good for a bond fund and pays that 4.3% dividend yield. The expense ratio is just 0.35% and again, these are bonds of good size companies like Sprint and Freeport McMoRan.
Almost three-quarters of the fund is in bonds of U.S. companies with the rest in developed nations and it’s well diversified across sectors as well with bonds from companies in nine sectors.
Because of that non-investment grade rating, this one jumps around and is the second riskiest of the funds we’ll look at today. It outperformed stocks for the first half of the year but broke down a little recently when stocks made a comeback. Still though, that dividend yield has made up the difference.
Next on our bond list is the iShares TIPS Bond ETF, ticker TIP, tracking by far the standout investment this year.
TIPS stands for Treasury Inflation-Protected Securities, so it’s a bond issued by the U.S. Treasury with the interest rate and value adjusting higher for inflation.
That inflation protection has made them one of the best investments this year and the TIPS Bond ETF pays a stellar 6.4% dividend yield. That’s not all! Because they’re issued by the U.S. Treasury, the payment on TIPs is guaranteed and interest is free from state and local taxes. The bond fund doesn’t have that guarantee but since it only holds TIPS bonds, its assets are always going to be safe.
With the general rise in interest rates, the TIPS fund has suffered the losses seen in all bond funds but you can see how it really protected your money during the worst of the stock crash. When stocks in the S&P 500 were down 20% at the June low, the TIPS fund was down just 12% and still produced that 6%-plus dividend.
In fact, the volatility on the TIPS ETF is the lowest in our group and less than a third of what you see in the stock market. For its dividend, low volatility and that inflation protection…this could be the best bond fund in the group but I like our last two funds just a little better.
Those last two more bond funds include one with the highest upside potential and the other with a perfect balance between risk and return but I want to help you with what to look for in these as well as how much to invest.
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What to Look For and How Much to Invest in Bonds
Bond funds offer an easy and cheap way to invest in bonds, usually holding thousands of individual bonds in a single fund. Investing directly in each bond usually isn’t cost effective for investors because you pay a commission on each bond and don’t get the diversification you need.
The biggest question you need to answer though is what kind of bonds do you want and the level of protection you need. Just like stock funds, there are bond funds for every type of fixed income investment from the safest government treasuries to higher-yielding and higher-risk junk bonds. For most investors, going with a total bond market fund will give you a little of everything to balance risk, return and yield.
How much of your money you invest in a bond fund depends on how much safety you want from a crash in stocks. For example, someone with five years to retirement needs much more portfolio protection and stable cash flows than someone in their 20s. The older investor might go as high as half their money in bonds while younger investors will still want at least five- or ten-percent. I would always have something in bonds though, not just for that protection from a crash but to take advantage of lower prices when stocks do fall.
Next on our bond ETF list is one we’ve talked about before and one of my favorites, the Global X SuperIncome Preferred ETF, ticker SPFF.
Now a preferred share is somewhere between stocks and bonds. It’s not a debt obligation like a bond but includes a fixed dividend payment that’s higher than most stocks. Preferreds get their dividend paid out before stockholders so it’s a little less risky and most convert to a regular stock at a certain price.
So preferred shares don’t have quite the upside return as stocks but offer higher yields and the safety of bonds. Why I like this one is partly on that safety but also you do get a higher return than a bond portfolio so it’s really the best of both worlds.
The Global X Fund invests in the 50 highest-paying preferred shares and produces a 6.4% dividend yield against an expense ratio of just 0.6% which is really good for one of these specialized ETFs.
The fund skews a little towards financials and bank stocks because those happen to be the ones that pay the highest yield on preferred shares. You’ve got a lot of big bank names in here like Wells Fargo and JP Morgan along with some smaller names like Ally Financial.
That said, it is the most volatile of the group and breaking that rule for half the risk compared to the market. With a standard deviation of almost 17% it’s still less risky than stocks but not as much as the true bond funds. I wanted to include it though because I think it’s a great option for investors that want a little of both stocks and bonds.
That bond-like part of the preferred shares has done its part this year and not only has the fund outperformed the broad stock market index but you can see it hasn’t crashed lower either, so that idea of lower volatility.
Bond ETF Every Investor Should Buy
I’ll reveal my favorite bond ETF next but I want to get your input on this as well. I know stocks are the popular investment and will always be the biggest part of your portfolio but how much do you have in real estate and bonds? So, scroll down and let me know, what percentage of your portfolio is in these other two asset classes and why?
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My favorite bond fund is actually the lowest dividend of the group but has beaten the market this year, protecting your money, the Invesco Senior Loan ETF, ticker BKLN.
The fund holds more than 140 large institutional loans. Most of these are going to be non-investment grade which means they’re a little riskier but pay higher yields. Most loans are due within five years which means they don’t have quite the interest rate risk as other bonds, so as rates rise, this bond fund won’t lose as much as others.
The dividend yield is lower on this one at just 3.4% because these are short-term loans but the volatility is one of the lowest in the group, really helping to offset the risk from stocks in your portfolio.
With fears of a recession and rising rates, the loans have taken a hit just like that high yield bond fund but with an eventual rebound in the economy, this one should produce a strong upside price return along with the dividend.
Even on higher rates and those recession fears though, this one has held up extremely well, beating the stock market by more than 6% in the first half beyond a dividend yield more than twice the market average.
Check Out the Entire ETF Stocks Series
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