Fixed Income public brochure that illustrates why the bond window of opportunity is now open for long-term investors.
Why Back to Bonds?
The Bond Window of Opportunity Is Open for Long-Term Investors
Without a doubt, cash was king in 2022 and into 2023. But markets have changed substantially. This year may be a pivotal point for investors sitting in cash, certificates of deposit, Treasuries or money market funds, one you don’t want to look back on and ask, “Why didn’t I move out of cash?” or “Why did I wait so long?” We believe now is the time to consider moving into bonds. Markets moved quickly at pivot points in the past, and opportunities to capitalize on changing dynamics disappeared quickly as well.
Putting a plan in place now- including diversified income strategies and broader asset management- ties into solid long-term financial planning. Investors may also consider exploring resources on blockchain wealth management as an addition to traditional fixed-income allocations.
Which Offers More Potential?
Comparing a 5-Year Bond to a 1-Year CD
At first glance, yields on cash and bonds suggest a similar return potential. You might even think that a slightly higher return for bonds isn’t worth the risk. But it’s important to understand what those yields mean, the time period they represent and how it could impact returns. So let’s compare how a hypothetical five-year bond and a short-term cash equivalent vehicle such as a CD might perform over time.
Will 1-Year CDs Pay Off?
Consider this hypothetical example: if a bond does not default, the investor would earn a total return of 5% over five years. A 1-year CD may also offer a 5% return in the first year, but the investor must reinvest the proceeds each subsequent year at the prevailing interest rate.
Over the next five years, CD rates could average 4%, 3%, or even 2%. Historically, when the Fed has cut rates, CD yields have fallen as well. By locking in attractive bond yields today, investors can reduce future reinvestment risk—the possibility of having to reinvest funds in lower-yielding CDs or other instruments.
This kind of long-term yield strategy aligns with advice from seasoned financial planners who help retirees and investors balance income needs and risk- similar to thoughtful guidance available through comprehensive financial planning for seniors.
Source: MFS research. This example is for illustrative purposes only and is not intended to predict the returns of any investment choices. Compounding is the process where money earned from investments such as interest or dividends is reinvested to earn more.
What to Consider?
Potential of Active Management Versus CDs
While it can be tough to give up the stability of money markets and CDs, that stability can come with a large opportunity cost over time. It may be time to consider bonds and active bond managers. Active managers strive to outperform the broad bond market indices, potentially providing the returns and income needed to pursue long-term goals. While certain bonds may offer higher current income, they are also associated with greater-than-average risk and the principal value and return will fluctuate with market conditions compared to CDs.
In 1924, MFS launched the first U.S. open-end mutual fund, giving millions of everyday investors access to the markets. Today, MFS operates as a full-service global investment manager, serving investment professionals, intermediaries, and institutional clients.
MFS has one clear goal: to create long-term value for clients by allocating capital responsibly. The firm combines collective expertise, thoughtful risk management, and long-term discipline to achieve this goal.
Teams of diverse thinkers actively debate ideas, evaluate risks, and uncover what they believe are the best investment opportunities. Their approach is supported by a culture of shared values and collaboration, ensuring decisions are both informed and responsible.
Important Risk Information
Bond: Investments in bonds and other debt instruments may lose value if the credit quality of the issuer, borrower, counterparty, or underlying collateral declines—or if investors perceive it to have declined. Economic, political, issuer-specific, or other conditions can also affect value. Some types of debt instruments react more strongly to these factors and are therefore more volatile.
Debt instruments carry interest rate risk. As interest rates rise, bond prices generally fall. Portfolios that hold bonds with longer durations usually experience larger price declines than those with shorter durations during rising rates.
At times, especially during market turmoil, large portions of the market may have low or no trading activity. This situation can make it difficult to value investments and may prevent selling at a desired price.
For bonds trading at negative interest rates, price movements respond to interest rate changes just like other bonds. However, if held to maturity, a bond purchased at a negative rate is expected to produce a negative return.
Municipal Bond: Investments in municipal instruments can be volatile and significantly affected by adverse tax or court rulings, legislative or political changes, market and economic conditions, issuer, industry-specific (including the credit quality of municipal insurers), and other conditions. Because many municipal instruments are issued to finance similar projects, conditions in certain industries can significantly affect the portfolio and the overall municipal market.
Definitions
Bond: When investors buy bonds, they are making loans to a company, government or institution. In return, the company promises to make regular interest payments at a set rate (coupon) and repay principle at a set date (the maturity).
Certificate of deposit: A CD is a savings product that holds a fixed amount of money for a fixed period of time at a fixed interest rate. CDs are considered to be a safe investment options, but they do come with early withdrawal penalties.
Yield to worst: For fixed income securities, yield is the discount rate that equilibrates the net present value of all future cash flows to the current market value. Average yield is the equivalent exposure weighted average yield to worst, which is typically the lowest of the yields to each potential call or put or the yield to maturity, whichever is worst.
Important information:
The Bloomberg US Aggregate Index measures the US intermediate-term, investment-grade bond market, The Bloomberg Municipal Bond Index measures the US municipal bond market. Municipal Bonds: The Bloomberg US Municipal Bond Index, which measures US municipal bond market. US Cash: The Bloomberg 1-3 Month Treasury Bill Index, which measures US Treasury bills with a maturity of between 1 and 3 months.
FAQs:
1. How do bonds compare to short-term cash instruments like CDs?
A 5-year bond can offer a guaranteed yield over its term, while a 1-year CD must be reinvested each year at the prevailing interest rate. If rates decline, CD returns may drop, whereas bonds lock in the yield today.
2. What is yield to worst (YTW)?
Yield to worst is the lowest potential yield an investor could receive on a bond without the issuer defaulting, considering all possible call or put dates. It represents a conservative measure of expected returns.
3. How do bonds generate returns?
Investors earn returns from interest payments (coupon) and potential price appreciation. When held to maturity, the principal is repaid at the agreed date. Bonds act as loans to governments, companies, or institutions.
4. What role should bonds play in a long-term portfolio?
Bonds provide income, diversification, and stability, helping investors manage risk while pursuing long-term financial goals. Active management can enhance returns compared to holding only cash or CDs.
5. Where can I find benchmark comparisons for bond performance?
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US Aggregate Index: Measures the intermediate-term, investment-grade US bond market
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Municipal Bond Index: Measures the US municipal bond market
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US Cash (1-3 Month Treasury Bill Index): Measures short-term Treasury bill returns
