Why to Consider Longer-Term Bonds Now

Short-term bond yields are high currently, but with the Federal Reserve poised to cut interest rates investors may want to consider longer-term bonds or bond funds.

High-quality bond investments remain attractive. With yields on investment-grade-rated1 bonds still near 15-year highs,2 we believe investors should continue to consider intermediate- and longer-term bonds to lock in those high yields. By focusing more on short-term bond investments, investors likely will face reinvestment risk once the Federal Reserve begins to cut interest rates, as it is widely expected to do this year.

However, investors may be a bit reluctant to do that given how high short-term yields are. Why invest in a longer-term bond when it offers a lower yield than what you can earn in short-term investments like Treasury bills, short-term certificates of deposit (CDs), or money market funds? It's a question we're asked often, and if it's a question you're asking, you're likely not alone. The amount of money market fund assets has been rising sharply for years—their yields have risen sharply following the aggressive pace of Federal Reserve rate hikes that began nearly two years ago.

Money market fund assets have risen sharply over the last few years

Short-term bond yields, and the funds that hold them, are admittedly attractive today. Three- and six-month Treasury bill yields are above 5%, at levels not seen since before the global financial crisis of 2008-2009. Those high yields come with relatively low volatility and generally lower price declines versus securities with longer-term maturities when yields rise. If you own a three-month Treasury bill and other Treasury bill yields rise, the price of your three-month bill might not fall much because it matures so soon, and when it matures you can reinvest at a higher interest rate.

However, if you hold a five-year Treasury note and yields rise, you'll have to wait a long time for it to mature before you can take advantage of those higher yields. If you wanted to sell that note in the secondary market, it would likely be sold at a discount because the buyer would need the additional price appreciation to make up for that income gap. That's why intermediate- and long-term bond prices tend to be more volatile than short-term bond prices.