4 Mistakes to Avoid With Your Bond Portfolio Right Now

Key Takeaways

1. Recent events underscore why conservative investors shouldn’t just be holding bonds—they should also hold some cash.
2. Some of the consternation about bond-price movements recently could be nicely solved with investors taking a step back, thinking about their anticipated time horizon till they need their money, and using that to inform what types of bonds to invest in.
3. Another mistake to watch out for is letting yield dictate what you’re holding in your bond portfolio.
4. The last risk here to avoid is ignoring costs—and that’s an evergreen risk rather than one that’s just relevant during market volatility.

Margaret Giles: Hi, I’m Margaret Giles for Morningstar. Recent market activity has left many investors scratching their heads about bonds. Joining me to discuss four traps that investors should avoid in the current turmoil is Christine Benz. Christine is Morningstar’s director of personal finance and retirement planning, host of The Long View podcast, and author of the bestselling book, How to Retire: 20 Lessons for a Happy, Successful, and Wealthy Retirement.

Thanks for being here, Christine.

Christine Benz: Margaret, it’s great to see you.

What Is Unusual About the Bond Market in 2025?

Giles: So, before we talk about any mistakes, I want to start talking about what’s been going on in the bond market. So, what’s been so unusual about it?

Benz: Well, typically, Treasury bonds and other high-quality bonds are a really nice diversifying asset for stocks. We’ve seen in many previous periods where stocks have lost ground. High-quality bonds typically hold their value. They may even gain a little bit during such periods. What we’ve seen during the recent turmoil has been a little bit more of a unified pattern, where we’ve seen Treasury yields rise, and that means their prices fall on days when stock prices are also falling. And this is not unprecedented. We actually had a little bit of a bobble in terms of Treasury prices at the beginning of the pandemic. I think that was largely for technical issues, but then again in 2022, when we saw both stocks and bonds fall due to rising interest rates.

So, we have seen something like this before, but the thing that has people worried is whether it represents kind of a loss of faith in US-denominated assets. Are, are investors saying, “Well, I’m not sure about the policy in place here. I’m going to take my safe money elsewhere”? That’s still an open question, I think. But one thing I would throw out there is that it does appear that the market is a little bit concerned about the tariffs being inflationary, and of course, that’s never good for bonds, that there may be some concern that rising interest rates could be in the offing and that would hurt bond prices. So, the explanation could be that simple. We just don’t know at this time.

How Much Cash You Should Hold in Your Bond Portfolio

Giles: OK. So now that we have the context, let’s move on to some of these mistakes that investors should avoid. So, you say that recent events underscore why conservative investors shouldn’t just be holding bonds. They should also hold some cash. Why is that, and how much cash should they be holding?

Benz: Right. We do this annual diversification paper where we examine correlations among various asset classes. The big winner over the past decade in terms of diversifying US equity exposure was actually cash. And the reason was largely that 2022 year that I referenced, when both stocks and bonds responded to rising interest rates. They both fell at the same time. Well, what did cash do during that period? It actually gained a little bit of ground. And it’s environments like that or the current one—that’s why I often recommend that retirees hold a couple of years’ worth of portfolio withdrawals in cash investments. It’ll save them from having to invade their bond portfolio if it hits a little bit of a speed bump.

For people who are still working, the standard rule of thumb is maybe three to six months’ worth of liquid reserves. I always say for high earners or people who have more-specialized career paths, if they can nudge that a little higher, that’s probably a good practice, especially if we’re in an environment like the current one where people are concerned about recession risk, potential job losses down the line. I think it only makes sense to protect yourself by holding a little bit of an extra buffer. But also remember not to overallocate to cash, because if we’re worried about inflation, and that’s definitely on the radar of things that we’re concerned about as investors, you would want to make sure that you’re not holding too much in safe investments that have limited return potential. The return you get is your yield, and it’s, it’s just not all that much these days.

How to Pick the Right Bond Investments for Your Time Horizon

Giles: Right. So, you also think it’s a mistake to not use your time horizon to determine what kinds of bonds to hold. So how should investors go about doing this?

Benz: Right. I think some of the consternation about bond price movements recently could be nicely solved with investors taking a step back, thinking about their anticipated time horizon till they need their money, and using that to inform what types of bonds to invest in. So, some investors might just want to hold individual bonds to maturity or build a laddered portfolio of bonds maturing on different dates. I think the defined-maturity ETFs can be a nice product for this use case as well, where you’re holding an ETF that is going to hold a group of bonds all set to mature on a given date. Or alternatively, if someone wanted to be a little bit more minimalist about it, I think you could hold a combination of cash and short- and intermediate-term bond funds.

So again, cash for maybe the next one to two years of my anticipated spending needs, then maybe a short-term bond fund for my spending over, say, a three- to five-year time horizon, and then if I have a spending horizon of, like, five to 10 years, there I might hold intermediate-term bonds. So, I don’t think investors need to get too complicated with it. Core, short, and intermediate-term bond funds combined with cash can do the job nicely, too.

Why Yields Should Not Dictate Your Bond Portfolio Holdings

Giles: Right. So continuing this vein of how you choose your bonds, another mistake to watch out for is letting yield dictate what you’re holding. Why is that such a risk?

Benz: One thing we’ve seen during this and other periods of bond market volatility, especially when there are worries about a recessionary environment, is that those higher-yielding bonds, which are typically issued by lower-quality companies, companies that have a little lower-credit rating, what we see is that their prices often fall more than higher-quality bonds. And indeed, we’ve seen that spread, that yield differential between higher-quality bonds and lower-quality bonds, really widen out during this period, and that reflects investors’ uncertainty about those lower quality issuers being able to make good on their debt payments.

And so I always say, you know, you might want to hold some of these higher-yielding credits whether high-yield bonds or bank-loan investments/floating-rate investments, or even kind of a multisector bond fund. You’d want to hold it around the margins of your bond portfolio. You’d use it to augment your high-quality fixed-income exposure, because when push comes to shove, in environments like the current one where investors are feeling a little bit skittish, they will tend to throw the lower-quality bonds overboard first. And so you would just want to make sure that the mainstay of your fixed-income portfolio would be fairly high-quality in terms of its complexion.

Why Fixed-Income Investors Need to Pay Attention to Costs During Market Volatility

Giles: OK. So finally, last risk here to avoid is ignoring costs, and now that’s an evergreen risk rather than one that’s just relevant during market volatility. So why are expenses so important for fixed-income investors?

Benz: Right. Morningstar, of course, has been banging the drum on this point about investors really cutting costs in terms of their investment products, and it’s especially important in fixed income because the return you earn is relatively constrained, so it’s roughly equivalent to whatever your starting yield is. If you have a 10-year bond and yields are 4.5% today, well, that’s probably going to be your return over a 10-year holding period. And so when you think about expenses, while you probably wouldn’t want to pay a 1% expense ratio, effectively giving up a fourth of your return, because you know that return is fairly constrained.

Investors should pay attention to costs across all of their investment types, but it makes sense to be especially parsimonious in the fixed-income realm where your return prospects are pretty limited.

Giles: All right. Absolutely. So this has been really helpful, Christine. Thanks for getting us some context on what to look out for.

Benz: Thank you so much, Margaret.

Giles: I’m Margaret Giles with Morningstar. Thanks for watching.

Watch 5 Things to Do Today If You Want to Retire in 5 Years for more from Christine Benz.