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Investment outlook for a changing market

Policy questions and continued Fed action will shape U.S. economic growth and inflation in 2025. As a strategy, projected fixed income returns over the next decade could provide an attractive risk-return trade-off for specific client needs.

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INVESTMENT OUTLOOK

An environment favorable to bonds

Amid a backdrop of global straining against inflationary headwinds, the United States experienced exceptional economic and financial market performance in 2024. Your clients may be wondering, “Will it continue, what’s the investment forecast, and how can I prepare for 2025 and beyond?” The Vanguard Economic and Market Outlook for 2025 offers some guidance—including investment insights about the potentially favorable long-term environment for bonds.

Monetary policy in most developed markets has meant falling inflation the past two years, accompanied by slowdowns. But the United States saw accelerating economic growth and full employment, with no discernible effect from restrictive monetary policy.

Supply-side forces, including a surge in both labor productivity and available labor, have been tailwinds aiding the U.S. economy’s resilience. Among the downside risks to bonds and equities we’re most closely monitoring is a rise in long-term rates due to continued fiscal deficit spending or removal of supply-side support. The potential upside for bond returns, however, should not be discounted.

Evaluating the long-term attractiveness of fixed income

Fixed-income markets have flourished as part of the recent U.S. growth story. In looking ahead to 2025, our investment forecast notes several factors likely to continue a hospitable backdrop for bonds into the long term:

  • Higher starting yields have greatly improved the risk-return trade-off in fixed income.
  • Over the next decade, we expect 4.3%–5.3% annualized returns for both U.S. and global ex-U.S. currency-hedged bonds.
  • Although we expect rate cuts to reduce the Fed’s policy rate to 4%, cuts beyond that would prove difficult, as any weakening of growth would have to be weighed against a potential inflation revival.
  • While central banks are now easing monetary policy, we maintain our view that policy rates will settle at higher levels than in the 2010s. This environment sets the foundation for solid cash and fixed income returns over the next decade.
  • The persistence of supply-side drivers (labor productivity and available labor) would support trend growth and thus, real rates. Alternatively, risks associated with geopolitics, global trade, and immigration policies could also keep rates high, due to inflation expectations.

Within this overall 2025 investment outlook, our U.S. equity view is more cautious—ultimately, high starting valuations will drag long-term returns down. Our structural theme holds even in a scenario where central banks briefly cut rates below neutral to allay temporary growth wobbles. Our forecast suggests the era of sound money—characterized by positive real interest rates—lives on.

Fixed income may serve an essential, yet nuanced role in your clients’ portfolios. Our fixed-income solutions help you construct portfolios designed to meet clients’ specific preferences and needs.

IMPORTANT: The projections and other information generated by the VCMM 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 VCMM are derived from 10,000 simulations for each modeled asset class. Simulations as of November 8. 2024. Results from the model may vary with each use and over time. For more information, please see the important information slide.

PORTFOLIO SOLUTIONS

Fixed income solutions tailored to client needs

The way your clients process changing market conditions reflects specific needs, risk tolerances, and goals that also guide how you construct the fixed income portion of their individual portfolios. We’ve assembled these conceptual portfolios to guide how you align the appropriate fixed income opportunity with the power of behavioral coaching. Consider them as a launching point for how you can customize fixed income holdings according to your clients’ unique objectives.

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Diversify risk

Concerned about volatility and reduction of principal.

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Total return

Comfortable with higher volatility in exchange for higher potential returns.

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Income

Rely on bond income to meet spending needs.

Bonds to diversify risk

Client type:

They’re concerned about volatility, and don’t want to risk spending down principal.

Action:

Pair high-quality bonds with traditional equities or separately managed accounts.

Investments to consider:

Behavioral coaching takeaways:

  • Address client anxieties by emphasizing that high-quality fixed income investments such as Treasury, core bond, and intermediate-term corporate bond fund investments often move in the opposite direction of equities when the stock market sells off.
  • Reassure clients that their goals can still be within reach because they prepared this way for equity market downturn scenarios.
diversify risk

Bonds seeking total return

Client type:

They’re comfortable with higher volatility if it means an opportunity for higher potential returns.

Action:

Pursue a balance between exposure to higher quality Treasury and Core bonds and lower quality high-yield bonds and combine with other asset classes for diversified return.

Investments to consider:

Behavioral coaching takeaways:

  • When clients’ portfolios are well-diversified, clients are more likely to have exposure to whatever is performing well.
  • Any impact from exposure to poorer-performing asset classes will be limited and offset by other assets performing well.
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Bonds for income

Client type:

They need bond income to meet their spending needs.

Action:

Allocate to bonds with greater credit exposure. This can include diversified active bond funds, active/passive ones, high-yield, and active multi-sector, among others.

Investments to consider:

Behavioral coaching takeaways:

  • Having a steady income stream in the portfolio can relieve the pressure of having to sell equities to fund spending needs.
  • Emphasize to clients that current rate levels are relatively high, both historically and compared against the current dividend yield for equities.
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Vanguard fixed income investments

  • Help create portfolio stability, income, and more for your clients. Check out our full Vanguard fixed income lineup.
  • Explore active municipal and active taxable bond funds, as well as our active ETFs.
  • Discover how our low-cost advantage helps enable outperformance over time, without undue risk.
View fixed income funds
Portrait of Sara Devereux
Sara Devereux
Global Head of Fixed Income Group

Portrait of Sara Devereux

Sara Devereux

Global Head of Fixed Income Group

At Vanguard since 2019

In industry since 1992

Sara Devereux is a principal and global head of Fixed Income Group. Ms. Devereux has oversight responsibility for investment activities within the rates-related sectors of the taxable fixed income market including foreign exchange. Prior to joining the firm, Ms. Devereux was a partner at Goldman Sachs, where she spent over 20 years in mortgage-backed securities and structured product trading and sales. Earlier in her career, she worked at HSBC in risk management advisory and in interest rate derivatives structuring. Ms. Devereux started her career as an actuary at AXA Equitable Life Insurance. Ms. Devereux earned a B.S. in mathematics from the University of North Carolina at Chapel Hill and an MBA from the Wharton School of the University of Pennsylvania.

Timely insights
 

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Have questions about fixed income? Contact us.

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Disclosures and footnotes

All investing is subject to risk, including possible loss of principal. 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.

Diversification does not ensure a profit or protect against a loss.

Bond funds are subject to interest rate risk, which is the chance bond prices overall will decline because of rising interest rates, and credit risk, which is the chance a bond issuer will fail to pay interest and principal in a timely manner or that negative perceptions of the issuer's ability to make such payments will cause the price of that bond to decline.

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.