In early 2024, the Federal Reserve paused its anticipated interest-rate cuts in response to stronger-than-expected economic data. Then sticky inflation, geopolitical risks, and record-high U.S. government debt pressured bond prices, increasing volatility and undermining the traditional role of fixed-income as a portfolio stabilizer.
With fixed income mostly not behaving as expected, we’ve heard from advisors that clients are asking tough questions like “Why isn’t my bond allocation holding up?” and “Isn’t fixed income supposed to be the safe part of my portfolio?”
These concerns reflect an essential truth: With fixed-income risks changing, legacy assumptions must evolve. Bonds may no longer be inherently “safe,” but with the right strategy, they still support durable, diversified portfolios.
How we got here. One of the most significant headwinds facing fixed-income markets is the explosion in U.S. government debt, which now exceeds 120% of GDP and is projected to climb significantly higher.
Much of this growth stems from pandemic-era stimulus, but spending has remained elevated through successive policy initiatives aimed at modernizing infrastructure, expanding access to healthcare, and accelerating the clean energy transition.
Although these efforts are designed to promote long-term economic resilience, they have also contributed to rising deficits and, in turn, have fueled inflationary pressures in the short term.
As a result, investors have been demanding greater compensation for long-term lending, pushing up rates at the long end of the curve in recent years. This can be seen in the performance of long-duration assets. For example, the iShares 20+ Year Treasury Bond ETF has lost about 47% of its value over the past five years.
When adjusted for inflation, consumer prices have risen more than 25% during that period—the real purchasing-power loss exceeds 70%. In this environment, relying heavily on long-duration bonds may no longer provide the risk-adjusted benefits investors have historically expected.
Another long-term trend investors had come to rely on has also broken down: the diversification benefit of owning bonds and stocks. A 60/40 portfolio once promised that falling stock prices would be offset by rising bond prices. But in 19 of the last 40 quarters, stocks and long-term bonds moved in the same direction.
The upshot is that advisors need to reassess how duration exposure fits within a broader risk budget and whether traditional core bond allocations still make sense. Investors and advisors must be more nimble and creative with their portfolios’ fixed-income allocations. Here are three ways to navigate today’s interest rate environment:
Set a risk budget. Old-style static allocations, such as maturity ladders, may not be responsive enough to insulate investors from volatility. An approach that compares relative value across maturities, sectors, and asset classes can add value when applied systematically and thoughtfully.
Set a risk budget, or the amount of risk an investor is willing to allocate across different asset classes or strategies, with broad diversification targets. Monitoring those attributes regularly, or when the market regime changes, can add a great deal of benefit.
Go beyond Treasuries and investment-grade corporates. Consider including floating-rate assets, bank loans, collateralized loan obligations, asset-backed securities, or sectors such as real estate, municipals, or high-yield bonds in portfolios.
Shorter-duration securities such as Treasury bills or ultrashort bond funds can also help. These exposures are available via ETFs, or separately-managed accounts (SMAs) for high-net-worth investors.
Actively manage fixed income. Buy-and-hold is no longer enough; fixed income needs active management. Strategies that benefit when rates rise or become volatile can smooth portfolio volatility. Examples include interest-rate-hedged bond ETFs or funds that tactically adjust duration based on rate expectations.
For advisors navigating this new reality, it’s essential to reassess the role of duration in client portfolios and consider whether it’s helping or hurting. Introducing strategies suited to rising-rate or volatile environments can add diversification.
Advisors should evaluate holdings based on both yield and overall resilience. Bonds may no longer be inherently “safe,” but with the right strategy, they still support durable, diversified portfolios. Adaptability—not historical precedent—is the key to success in today’s evolving market.
Dean Smith is the chief strategist for FolioBeyond, and the portfolio manager of their RISR and FIXP exchange-traded funds.