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Are Bond ETFs Safe During a Recession?

are bond etfs safe during a recession

The past two quarters of 2022 have experienced negative growth, meaning that the United States is officially in a recessionary period. The definition of a recession is when an economy experiences two quarters of negative growth, and that is what happened.

Since the beginning of 2022, the S&P 500, one of the benchmark ETFs, has declined over 11% since the beginning of 2022. Due to this decline, many people are not confident that their investment is safe and will grow in value over time. 

During recessions, some investors might look for “safe haven” assets that grow in value even during a recession. During stock market declines, it’s not uncommon that investors lose confidence in benchmark ETFs and stocks in general, preferring bonds as they could be considered as “safer” and reliable investment compared to stocks. 

Generally speaking, bonds tend to grow in value at a slower rate compared to stocks, however they are considered less volatile whilst providing more reliable returns.

Bonds in general are their own asset class, and require lots of research for an investor to find out which bonds are at a fair value. Bonds also don’t receive as much media coverage as stocks do, so it might be easier for investors to start off with an actively managed fund, like a bond ETF. 

Considering that we are in a recession, however, one may wonder if bond ETFs remain “safe haven” assets during a recession. So, are bond ETFs safe during a recession? In order to answer this question, we will first define what a bond ETF is, then we will observe how bond ETFs have performed in previous recessions. Finally, we will give our conclusion about whether bond ETFs are safe or not during a recession.

What is a bond ETF?

A bond ETF (Exchange Traded Fund) is a fund that can be purchased in the stock market that specializes and invests exclusively into bonds. Bond ETFs generally invest in fixed-income securities, such as corporate bonds and Treasury coupons.

ETFs boast a small management fee, as they are actively managing the funds for the investors that decide to allocate funds to their ETF. This management fee is directly reflected in the price of the stock, therefore people do not have to pay for holding bond ETFs. In fact, some bond ETFs pay a monthly dividend to their investors.

There are many bond ETFs that specialize in many different types of securities, from treasuries to floating-rate bonds. One of the largest bond ETFs by assets under management (AUM) is the iShares Core US aggregate bond (AGG), with over $80 billion in AUM. It currently pays a dividend of over 3%, and the price of the ETF has remained in the 90-120 dollar range for over 20 years. Therefore, the ETF has been less volatile than the general stock market and had a healthy dividend, which can attract certain investors who like to play it safe.

Of course, if the rate of inflation during the same time period is higher than 3% then holding the bond ETF can still equate to less purchasing power. Subtracting the inflation rate from the bond yield gives the Real Rate of Return (RRR), which can still be negative during high inflationary periods.

Related: How Can the Bond Market Help Beginner Investors Diversify their Portfolio?

How have bond ETFs performed in previous recessions?

US-listed bond ETFs have only been around for 20 years, and in the past 20 years a notable recession that we have experienced is the 2008 real estate crisis, that plunged the United States (and the world) into a recessionary period. Therefore, let’s analyze charts of bond ETFs during this time, starting with AGG:

How have bond ETFs performed in previous recessions?

iShares Core US Aggregate Bond ETF ($AGG) performance since 2004. Source [Yahoo Finance.]

As you can see, AGG did experience some extreme volatility during the 2008 crash, going from around 100 all the way down to 90, which is a 10% loss. However, the ETF still paid out dividends during the entire crash and recovered within a year.

Let’s check another bond ETF, the Vanguard Total Bond Market ETF, another bond ETF that has purchases diversified bonds across all sectors (treasury bills, corporate bonds, and more):

How have bond ETFs performed in previous recessions? AGG

Vanguard Total Bond Market Index Fund ETF ($BND) performance since 2008. Source [Yahoo Finance.]

As you can see, during the 2008 crash BND also took a hit, going from roughly 76 all the way down to 70. Therefore, there was a drop, but the drop in price was less than many other stocks and ETFs during that period. Beyond that, BND also never stopped paying its dividends.

This shows that indeed, the price of bond ETFs can be correlated with the direction of the stock market. However, bond ETFs may not be as volatile as stocks, while still offering healthy dividend yields during a recession. 

Should we invest in bond ETFs?

This is the million dollar question, and there is no clear yes or no answer. It all depends on your trading plan. Conservative investors may want to allocate a portion of their portfolios to bond ETFs, as they know that they can obtain healthy dividends from their investment without too much risk of the etf falling. More aggressive investors may think that the gains provided from bond ETFs are simply too low and would prefer taking larger risks in the hopes of obtaining larger gains.

There are two types of wealth: wealth preservation and wealth appreciation. For wealth appreciation, usually people want to make their portfolio grow aggressively and are willing to take more risks in the hope of increasing their cash rapidly. For wealth preservation, it is all about preserving the wealth and ensuring that one’s portfolio remains nice and steady. 

Therefore, bond ETFs could make sense for people looking for some preservation of wealth: bond ETFs are less volatile than the stock market and generally offer healthy dividends, which is great for people who are looking to park some of their excess cash in a safe manner. However, if one is looking for rapid gains found in certain tech or smallcap stocks, then perhaps bond ETFs may not make sense for that person. 

Ultimately, it boils down to having a clear investment strategy before investing. There are many investment strategies that lead to wealth, so it is always healthy to do some research before investing in anything. Ask yourself the question: what kind of investor are you? And do bond ETFs make sense in your portfolio?

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