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The Fed is likely to keep rates high. How to generate income and reduce risk


Near-dated Treasurys have seen a sizeable boost since the Federal Reserve has embarked on its rate-hiking campaign, and a strategy that allows investors to generate income in the short term is taking off. Bond laddering, which involves buying a portfolio of issues with staggered maturities, picked up steam this year, according to data from Charles Schwab. The brokerage firm recently reported that it picked up $1.3 billion in new bond ladder assets during the first six months of 2023, compared with $1.9 billion in all of 2022. The benefit of bond laddering is that it allows investors to spread interest rate risk, which is especially important as the Federal Reserve has just hiked rates for the 11th time. Rising interest rates can cause price swings for bonds, particularly for longer-dated issues. With the 3-month Treasury bill yielding 5.4%, even legendary investor Warren Buffett is snapping up government bonds . US3M US6M 1Y line U.S. 3 month and 6 month Treasury yields “Typically, the yield curve is upward sloping, and you have to go longer term or down in credit to get yield, but now you can stay high-quality and maintain liquidity in the portfolio,” said David Lafferty, managing director, product strategy and development at Schwab Asset Management. To that effect, the firm this week launched a trio of Treasury bond laddering strategies: six-month, 12-month and 24-month offerings, managed by its Wasmer Schroeder Strategies team. Two kinds of bond investors Though strategists have been encouraging investors to add longer-dated bonds — especially with the expectation that the Fed may be close to the end of its tightening campaign — a short-term bond ladder can still serve a purpose in an investor’s portfolio. For instance, 3-month, 6-month and 1-year Treasurys each yield well over 5% at the moment, and investors with short-term needs can ladder these issues. “There are two bond investors: total return and income,” Lafferty said. “The historical data says that as you reach that peak in rates, if you’re total return, it makes sense to add a bit of duration to the portfolio.” Duration is a measure of a bond’s price sensitivity to interest rate changes, and issues that are longer dated have the greatest duration. “For income investors, those higher yields are still at the shorter end, and these might be people who are pulling income out of their portfolio or retirees who need to spend their current income,” he added. For investors who are thinking longer term, Schwab offers 5-year to 15-year ladders, as well as a 1-year to 5-year variety.

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