The bond market: a great opportunity to lock in passive income?
The bond market is where governments and companies raise capital by issuing bonds. These are kind of like IOUs that pay regular interest and return the original investment at maturity. Investors typically buy bonds for their relative safety and predictable passive income.
That said, I believe a portfolio of well-chosen stocks is the best way to achieve long-term success in the stock market. For context, bonds made up a tiny proportion of my portfolio in 2024. But they have their place.
For those of us who are new to bonds, the yield works in a similar way to a companyâs dividend. Each bond is issued with a coupon. This is the fixed annual interest payment â expressed as a percentage of the bondâs face value â that the issuer agrees to pay the bondholder until maturity.
However, bond prices move up and down like stocks. And the yield moves inversely to the price. That means when prices fall, yields rise, and vice versa.
So why do bond prices rise and fall? Itâs essentially about risk. If bond market participants get concerned about a government or companyâs ability to service debt (pay bondholders) then bond prices will likely fall.
Opportunity beckons in government bonds?
Right now, both US and UK government bond yields are elevated compared to most of the past decade. Higher interest rates are clearly part of the equation, but so is risk.
The US 10-year Treasury yield stands around 4.45%. Thatâs high by recent standards. It reflects concerns about persistent inflation, large government deficits, and uncertainty over the future path of interest rates.
Similarly, the UK 10-year gilt yield is hovering around 4.56%. Sticky inflation and fiscal worries are prompting investors to demand higher returns for holding government debt.
Where could I gain exposure?
Investors can simply buy individual bonds through their brokerages. Personally, I have some interest in short-duration bonds but none in the long end â government debt and deficits are too high.
So is this an unmissable opportunity? Maybe in some parts of the market, but not everywhere.
Another way to gain exposure is through considering an investment in iShares Core US Aggregate Bond ETF (NYSEMKT:AGG). Itâs one of the most popular and widely-held bond ETFs, offering investors broad exposure to the total US investment-grade bond market.
Launched in 2003 and managed by BlackRock, the ETF tracks the Bloomberg US Aggregate Bond Index, which includes US Treasuries, government-related bonds, corporate bonds, mortgage- and asset-backed securities.
The fund uses a sampling approach to mirror the indexâs performance and invests at least 80% of its assets in the underlying securities. With a low expense ratio of just 0.03%, iShares Core US Aggregate Bond ETF can be a cost-effective way to gain diversified fixed income exposure.
There are always risks, and this is no different. A US recession could really pull this ETF down. Likewise, pound appreciation or dollar weakness could make this investment an unprofitable one.
It currently has $125m in market assets and offers a 3.8% yield.
Likewise, investors may look to Berkshire Hathaway for bond market exposure. It doesnât pay a dividend, but invests heavily in US bonds. Berkshire’s now one of the largest holders of US Treasury bills, with nearly 5% of the entire short-term Treasury market. Thatâs about $314bn as of March.
The post The bond market: a great opportunity to lock in passive income? appeared first on The Motley Fool UK.
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James Fox has positions in Berkshire Hathaway. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
