Should You Invest in Stocks, Bonds, or a 4% CD?
Cash yields look more attractive than they have in years―here’s how to decide.
- Why we’re seeing that short-term bonds have higher yields than longer-term bonds.
- Are the losses that bond fund investors incurred last year enough reason to favor individual bonds over bond funds?
- Defining the role stocks play given the return prospects for bonds are so much better than they were just a few years ago.
Susan Dziubinski: Hi, I’m Susan Dziubinski with Morningstar. Higher yields on safe investments may have some investors debating whether they should venture into stocks or take the sure thing instead. Joining me to discuss that question today is Christine Benz. Christine is Morningstar’s director of personal finance and retirement planning.
Nice to see you, Christine.
Christine Benz: Hi, Susan. Good to see you.
Dziubinski: Let’s talk a little bit about the landscape for safe securities these days. How much better have yields gotten on cashlike and shorter-term securities over the past couple of years?
Benz: So much better. So, interest rates really bottomed in late 2020. Back in the fall of 2020, the 10-year Treasury bond was yielding well less than 1.00%, so 0.65%. And then by last fall, the 10-year Treasury was yielding 4.2%. So, just a huge difference, thanks to the Fed policy of increasing interest rates. Of course, we have had higher inflation during this period as well. Yields on shorter-term bonds have gotten even better. They’re higher than longer-term bond yields today. So, the six-month Treasury, for example, is yielding over 5% today. So, it’s hard to overstate what a seismic shift we’ve seen in the interest-rate landscape just in the space of a couple of years.
Dziubinski: Why is that happening, Christine? Why are we seeing that the short-term bonds have higher yields than the longer-term bonds? So, given that, why would anyone settle for a lower yield on a longer-term bond?
Benz: It’s a really good question, and this is what we’re talking about when we say that the yield curve is inverting. And the basic reason this is happening is that investors are looking into the future and saying, “Well, at some point, we think yields are probably going to decline.” And so, that 4.2% yield on a 10-year Treasury actually looks good relative to where it may go in the future. So, I’m going to lock in that higher yield, and I may even be able to pocket some capital appreciation. If yields indeed do go down, my old higher-yielding bond may be worth more. So, that’s the key reason that we’ve seen the longer-term bonds actually yield less during this period than the shorter-term bonds. With shorter-term bonds, investors are saying, “Well, I may have this higher yield today, but in six months or a year or whatever the term of the bond, I may be stuck with having to reinvest it at a lower yield at some point in the future.”
Dziubinski: Is that a good argument, then, Christine, for not investing a big share of your portfolio on something like CDs, the reinvestment risk if rates do go lower?
Benz: Well, I do think it’s a huge reason why you wouldn’t want to park your whole portfolio in CDs. Another huge risk for any fixed-rate investment, CD or a bond, is simply inflation risk, that you have your yield certainly and yields look a lot better, but inflation may gobble up every bit of that yield at today’s elevated prices. So, that’s the other key risk factor. That’s the reason why I would say investors should potentially park their near-term spending needs in CDs. Yields are certainly attractive, but then step out on the risk spectrum with their portfolio. So, venture into shorter-term bonds, venture into intermediate-term bonds and even stocks as a component of their portfolio. Even though you don’t have that benefit of that guaranteed yield, you do have that opportunity of long-term growth and the opportunity to outearn the inflation rate.
Dziubinski: Many investors are naturally worried a little bit probably about bond funds today, given the losses that they incurred last year. Is that a reason to favor individual bonds over bond funds?
Benz: Well, I’ve been hearing a lot about the attractions of individual bonds as a way to think about addressing spending needs. Especially, in retirement, there’s a lot to like about matching your spending needs with the maturity of a specific bond. But I would also say in a way the safety of individual bonds is a little bit illusory in that in a year like 2022, even if you’re holding that individual bond and you plan to hold it to maturity, if you looked up its price, its price probably saw a little bit of a bobble during that period. So, there’s that issue. And then, the bigger issue in my mind is simply that smaller investors may have difficulty adequately diversifying using individual bonds. They may have difficulty finding exposures across credit qualities, across interest-rate sensitivities. And by the time they do that, and they build that portfolio that’s adequately diversified, they probably end up with something that is looking a lot like a bond fund and yet they’re not a professional bond fund manager. So, I think that for many investors, using bond funds makes a lot of sense because it gives you that all-in-one diversification. It gives you that professional management, and you can get it at a very low fee. But you do have to be willing to put up with periodic bobbles in principal value like we saw last year.
Dziubinski: Let’s talk a little bit about stocks, Christine. What role do stocks play in an environment like the current one we’re experiencing, given the return prospects for bonds are so much better than they were just a few years ago?
Benz: Right. It’s certainly a reason to not overlook bonds. I think everyone hates bonds right now. Investors have seen bonds be pummeled over the past year and they worry that there are even more interest-rate increases to come so that bond prices may not be stable from here. But I think it’s possible to overdue bonds as well because you do need that appreciation potential that comes along with stocks. You need the opportunity to outearn inflation. So, I like the idea of investors holding enough cash and bonds to meet perhaps the next decade’s worth of spending needs. So, for people who are in retirement, if they’re kind of building a runway in their portfolio, think about having cash, short and intermediate-term bonds, potentially inflation-protected bonds to meet that next 10 years’ worth of cash flow demands that you’ll be placing on your portfolio. But from there you want your portfolio to grow. And so, I would hold any overage in stocks. I think that’s a good way to back into a situation-appropriate asset allocation. And I would also mention, Susan, and you certainly focus on this a lot in your job, we know that stocks are still pretty attractively valued, too, that even though stocks have recovered a little bit so far in 2023, they have been pretty well beaten down. And so, there’s arguably much better upside potential for stock investors today than there was even a year ago.
Dziubinski: Well, Christine, thank you for your thoughtful insights into how we should be thinking about our cash, bond, and stock buckets today. We appreciate it.
Benz: Thank you so much, Susan.
Dziubinski: I’m Susan Dziubinski with Morningstar. Thanks for tuning in.
Watch “How to Make the Most of Your Retirement Accounts” for more from Susan Dziubinski and Christine Benz.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.