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INVESTING IN THE CHANGING ENVIRONMENT

Put cash to work in 2024

Help clients move out of cash to bonds. The persistence of higher real interest rates provides a solid foundation to make that move.

Check out these insights to better inform your client conversations.

Review the outlook​

Volatile markets have made the last few years a roller coaster for your clients. Now we’re in a new reality where interest rates are likely to remain higher for longer.

The U.S. economy has proved resilient despite Federal Reserve efforts to cool it to rein in inflation by keeping interest rates elevated, as noted in a recent commentary by Vanguard’s chief economist for the Americas, Roger Aliaga-Díaz. Given the economy’s continued strength and still-stubborn inflation, we believe that the Fed may not be in position to cut rates at all in 2024. But a soft-landing scenario with moderate Fed cuts can’t be ruled out.

Vanguard believes that a higher interest rate environment will serve long-term investors well, providing long-term risk-adjusted returns, but the transition may be bumpy.

 

Asset-class return outlooks

Our 10-year annualized nominal return projections, as of December 31, 2023, are shown below.

Please note that equity returns reflect a range of 2 percentage points around the 50th percentile of the distribution of probable outcomes. Fixed income returns reflect a 1-point range around the 50th percentile. More extreme returns are possible.

 

U.S. equities Global equities ex-U.S. (unhedged) U.S. aggregate bonds Global bonds ex-U.S. (hedged) U.S. cash
3.7%–5.7% 6.9%–8.9% 3.9%–4.9% 3.9%–4.9% 3.4%–4.4%
17.0% median volatility 18.3% median volatility 5.6% median volatility 4.3% median volatility 1.4% median volatility

 

These probabilistic return assumptions depend on current market conditions and, as such, may change over time.

Source: Vanguard Investment Strategy Group.

IMPORTANT: The projections or other information generated by the Vanguard Capital Markets Model® regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Distribution of return outcomes from the VCMM are derived from 10,000 simulations for each modeled asset class. Simulations are as of December 31, 2023. Results from the model may vary with each use and over time. For more information, see the Notes section below.

To help inform your client discussions and portfolio strategies, turn to our latest economic and market outlook. This update can jump-start the client conversations you’ll be having in the months ahead. Read on for tips on evaluating your portfolios, getting ready to invest, and guiding your client in this changing environment.

Evaluate your portfolio​s

You may have preferred cash or cash equivalents in recent years as you anticipated interest rate hikes by the Federal Reserve. But that rate-hiking cycle is likely over.

Continuing to overweight cash may prove to be another example of how what worked in the past may not work so well again in the future. It may be a good time to reassess how your fixed income portfolio is invested across maturities.

Consider the trade-offs of maximizing yield today by overweighting cash or very short-term bonds compared with moving out on the curve to take advantage of yields and better defend your portfolio from equity weakness (see chart below).

Returns on bonds compared to CDs

Bar charts showing that bonds (with the exception of U.S. high yield in two instances) have typically outperformed CDs

 

Sources: CD rates are from Bankrate.com. Annualized return delivered by the Bloomberg U.S. Aggregate Bond Index. U.S. Treasuries, U.S. high yield, and U.S. credit after the Federal Reserve stopping raising interest rates (we rounded dates to the nearest month-end). The blue bar shows the peak CD rate an investor could have locked in at the time the Fed was finishing its rate-hiking cycle.

Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

Of course, the typical practice is to align the duration of a portfolio allocation with your client’s approximate timeline, especially if money will be needed relatively soon. For needs within a year or so, cash remains an appropriate option, while short-term bond funds can work well for needs within the next few years.

 

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Cash or bonds? Which one is right for you?

Share this brochure with your clients to help them choose between a money market or other cash-like account and a bond fund.

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Get ready to reinvest ​

In this environment, many advisors have built bond portfolios with shorter duration profiles. In fact, roughly three out of four advisor portfolios that our Portfolio Solutions team reviewed in 2023 maintain meaningful underweights to duration.

But reducing duration for your long-term clients is more likely to reduce total returns than volatility, especially now that yields are at more attractive levels.

The chart below demonstrates the benefit of compounding interest on reinvested bond coupon payments (income return) over an extended period. Long-term investors should remain focused on both components of bond total returns: price return and income return. The bottom line: Don’t let excessive fear about duration risk disrupt your clients’ long-term total returns.
 

Intermediate-term bonds pay off over the longer run

Line chart showing that the total return for intermediate term bonds at 145.12% was higher than the total return for short-term bonds at 73.72% over the period from November 30, 2001, to June 30, 2023.

 

Source: Vanguard, 11/30/2001–6/30/2023. The short-term bond portion of these portfolios is represented by the Spliced Bloomberg U.S. 1–5 Year Government/Credit Float Adjusted Index, which includes the Bloomberg U.S. 1–5 Year Government/Credit Bond Index through December 31, 2009; Bloomberg U.S. 1–5 Year Government/Credit Float Adjusted Index thereafter. The intermediate-term bond portion is represented by the Spliced Bloomberg U.S. 5–10 Year Government/Credit Float Adjusted Index, which includes Bloomberg U.S. 5–10 Year Government/Credit Bond Index through December 31, 2009; Bloomberg U.S. 5–10 Year Government/Credit Float Adjusted Index thereafter.

Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

 

 

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Getting back into bonds - Choosing the right strategy

This analysis from Vanguard’s Investment Advisory Research Center (IARC) compares the effectiveness of an immediate lump-sum investment with dollar-cost averaging or waiting in cash to invest in the future.

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Active fixed income

Diversify your clients’ portfolio with active fixed income funds.
 

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Guide your clients

If your clients are resistant to getting out of cash, you can coach them through these volatile moments and put them at ease.

Start by helping your clients understand the different roles that bond funds and cash play in their portfolios and guide them toward the decision most likely to achieve their goals.

Clients often lack knowledge about how bond prices work and how to assess their returns. Here’s a great opportunity to educate them about:

  • How unusual 2022’s losses were.
  • Why higher interest rates increase bond returns over the longer run.
  • How to compare yields on bonds and bond funds to rates offered on money market and similar accounts.
  • Reinvestment risk, the hidden downside of money market and similar accounts.

 

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Now is the time to embrace bonds again

Share this piece with your clients about the benefits of a portfolio allocation back into bond funds or ETFs. It also discusses timely opportunities to be found in the bond market.

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Bonds or cash? Help clients choose wisely

Get guidance about how to talk to clients about bond returns.

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Guide clients confidently: Behavioral coaching toolkit

For additional help on navigating clients through uncertainty, review our behavioral coaching hub.

Try our Market Hindsight Tool

Have more questions? Contact us.

Disclosures and footnotes

 
  • For more information about Vanguard funds or Vanguard ETFs®, view detailed product information or call 800-997-2798 to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information are contained in the prospectus; read and consider it carefully before investing.
  • Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.
  • All investing is subject to risk, including the possible loss of the money you invest. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.
  • Investments in bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments.
  • U.S. government backing of Treasury or agency securities applies only to the underlying securities and does not prevent share-price fluctuations. Unlike stocks and bonds, U.S. Treasury bills are guaranteed as to the timely payment of principal and interest.
  • Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. These risks are especially high in emerging markets. \
  • IMPORTANT: The projections and other information generated by the Vanguard Capital Markets Model regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. VCMM results will vary with each use and over time.
  • The VCMM projections are based on a statistical analysis of historical data. Future returns may behave differently from the historical patterns captured in the VCMM. More important, the VCMM may be underestimating extreme negative scenarios unobserved in the historical period on which the model estimation is based.
  • The Vanguard Capital Markets Model® is a proprietary financial simulation tool developed and maintained by Vanguard’s primary investment research and advice teams. The model forecasts distributions of future returns for a wide array of broad asset classes. Those asset classes include U.S. and international equity markets, several maturities of the U.S. Treasury and corporate fixed income markets, international fixed income markets, U.S. money markets, commodities, and certain alternative investment strategies. The theoretical and empirical foundation for the Vanguard Capital Markets Model is that the returns of various asset classes reflect the compensation investors require for bearing different types of systematic risk (beta). At the core of the model are estimates of the dynamic statistical relationship between risk factors and asset returns, obtained from statistical analysis based on available monthly financial and economic data from as early as 1960. Using a system of estimated equations, the model then applies a Monte Carlo simulation method to project the estimated interrelationships among risk factors and asset classes as well as uncertainty and randomness over time. The model generates a large set of simulated outcomes for each asset class over several time horizons. Forecasts are obtained by computing measures of central tendency in these simulations. Results produced by the tool will vary with each use and over time.