2 Fixed Income ETFs to Consider Before the Fed Cuts Rates

The Federal Reserve appears set to cut interest rates for the first time since 2020 at its policy meeting later in September. It is expected to continue cutting through 2025, and the median expectation at this writing is a total of 2.25 percentage points of cuts to the federal funds rate by the end of next year.

As we appear to be entering a lower-rate environment, it might be wise to start thinking about strategically adding fixed-income exposure to your portfolio. Here are two ETFs in particular that might be worth a closer look and why now might be a great time to buy them.

2 Fixed Income ETFs to Take a Closer Look

We’ll get to the “why now” question in the next section, but here are two long-term bond funds that look interesting right now.

The first is the Vanguard Extended Duration Treasury ETF (EDV 0.17%)This fund has a very low expense ratio of 0.06% and a current yield of 4.2% and it invests in an index of long-term (20 to 30 years) U.S. Treasury securities. The average maturity of the bonds in its portfolio is 24.6 years and the average yield to maturity is 4.5%.

Second, the Vanguard Long-Term Bond ETF (BLV 0.34%) is similar in nature, but with a broader scope. About half of this ETF’s assets are invested in long-term government bonds, such as Treasuries, with the remainder invested in high-quality corporate bonds. This has the effect of increasing the overall yield (currently around 4.7%). Its expense ratio is even lower, at 0.04%.

So, the long-term bond ETF has a higher yield and a lower cost. Its main disadvantage is that, unlike the Treasury ETF, it has credit risk related to the companies that issue its bonds. This can make the ETF more volatile, especially in turbulent markets.

Why now?

The Federal Reserve is expected to begin cutting rates at its scheduled meeting later this month, and continue to do so gradually for at least a year or two. Bond yields — especially long-term bonds like those held by these ETFs — tend to move in the same direction as the federal funds rate. And since yield and price have an inverse relationship, lower bond yields could push up the prices of these ETFs.

In other words, these ETFs have portfolios of long-term bonds, many of which are relatively high-yielding today. As yields on new long-term bonds fall, the bonds already held by these two ETFs increase in value.

To illustrate this, let’s look at the performance of these two ETFs during the rate hike cycle in 2022 and 2023.

BLV data by YCharts.

While there is no way to predict future performance (or the Fed’s rate decisions) with complete accuracy, it is likely that these ETFs will rise if rates fall significantly.

To be perfectly clear, both of these ETFs are excellent buy-and-hold investments for those who need more fixed-income exposure. Now may be a great time to add them before rates start to fall.

How much fixed income exposure should you have?

There is not Perfect To answer this question, there is a common rule used by financial planners that involves subtracting your age from 110 to determine how much of your invested assets should be in stocks and the rest in bonds. For example, I am 42 years old, which implies that I should have about 68% exposure to stocks and 32% of my money in fixed income instruments like these two funds.

Of course, I tend to use this as a guideline rather than a hard and fast rule (I don’t have exactly 32% of my portfolio in fixed income). But it’s a good indicator of an age-appropriate investment mix, so if you have a bit of light fixed income exposure in your portfolio, some high-quality ETFs like these might be your solution.

Matt Frankel has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.