Why Bonds Belong in Your Diversified Portfolio (Even Now)

Fixed-income investors, bonds are rising to the occasion and looking attractive again.

Why it matters: Their yields are higher, and they have delivered as diversifiers against stock selloffs this year. Yet, uncertainty has muddled the outlook as the bond market seeks clarity about tariffs, inflation, and interest rates. Joining me is Paul Olmsted, who covers US fixed-income strategies for Morningstar Research Services. The senior manager research analyst explains why you need bonds for a balanced portfolio.

On this episode:

9 Questions on the Bond Market 2025

1. Let’s start with how you’re thinking about the bond market in 2025. Can you talk about what you have considered key moments this year?
2. As a follow-up, what is at the core of the bond market’s concerns?
3. We’re recording this episode on July 30 around 10:30 a.m. The Fed is expected to announce their interest rate decision this afternoon. Market watchers are predicting the Fed will hold rates steady. High interest rates pose a risk to bonds. What other risks should investors watch out for now?
4. Some bond investors are seeking a “Powell hedge” due to expectations that Trump could oust the Fed Chair. What are they hedging against, and is this something everyday investors need to think about?
5. What’s the probability of Trump firing Powell before the Fed Chair’s term ends in May 2026, and who would be the ideal candidate?
6. We have talked about how the memory of the worst bond market ever in 2022 is still lingering. However, bonds served as diversifiers during stock selloffs earlier this year. Why do you think bonds can’t shake the bad rap?
7. What’s the optimal bond allocation in a diversified portfolio during a high-rate environment? Should investors focus more on whether their holdings are short- or long-term, or is credit quality a bigger issue?
8. What are the best bonds for portfolio diversification?
9. What’s the takeaway for fixed-income investors for the rest of 2025?

Key Quote on the Bond Market and Market Volatility in 2025

I think investors in the market, not just in the market in the US, but in the market in kind of global markets, see the Fed as a voice of reason and really put a lot of trust in the Fed to do the right thing when it comes to monetary policy. And if that is somehow disrupted, I think that could certainly undermine what the Fed is doing and the world can lose confidence in that. So, that would ultimately lead to higher volatility.

The Takeaways: After the president’s April 2 announcement that he was going to institute widespread tariffs globally, bond markets saw a rise in long-term yields and wider credit spreads, says Olmsted. With the US Aggregate Bond Index yield near multiyear highs, investors should take advantage of this opportunity. Bonds can serve as a diversifier to investors through anticipated ongoing volatility. With fears of economic volatility and rising tensions at the Fed, bond investors can trust that good active managers can manage risks in their bond portfolios.

More From Morningstar on the Bond Market 2025

The markets have not seen long-term Treasury yields this high since before the 2008 financial crisis. Despite lingering fears from the bond market carnage in 2022, investors today should take advantage of elevated bond yields, says Olmsted. Olmsted lists three strategies that can provide higher income potential.

Bonds have been a balancing force for investors facing volatile equity market movements. Dan Lefkovitz tells investors what principles to invest by, no matter what comes next in the markets, and the key lessons we’ve already learned in 2025.

As tensions rise between the Fed and the Donald Trump administration, investors are looking for a voice that will not bend to political pressure and keep the US economy steady for the rocky road ahead, writes Sarah Hansen.

Jess Bebel, an associate multimedia editor at Morningstar, contributed to this article.