Zero to Hero: Is the Idea of Investing in Zero-Coupon Bonds Attractive Now?
- These bonds react to stock market changes and interest rates
- The conditions for them are ideal right now
- ETFs based on tracking zero-coupon bonds have been performing extremely well
You might not have heard much about zero-coupon bonds before now. This is a unique type of bond that offers some big advantages but that also has some crucial points for you to bear in mind too.
The Full Details
This is a type of bond that is issued by the US Treasury. You might seem them called Treasury zeros or STRIPS too. Unlike other types of bond, they are pretty risky.
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This is because they can move sharply depending upon market conditions. They will tend to rise when the stock market sees price falls or when interest rates are cut.
On the other hand, they will generally fall when the Fed pushes up interest rates. They shouldn’t be confused with Treasury Bonds, which are the safest types of investment around.
These are bonds that are offered at a discounted price but that don’t pay any interest. So, you need to make money on the price rising, rather than relying on interest payments to give you an overall profit.
They are typically purchased in ETFs, which makes them easy to invest in. An example is the Vanguard Extended Duration Treasury Index Fund (EDV). This is a fund that tracks zero-coupon bonds. In the year to date, it has already earned 15%. If we go back over a full year, the return is a mightily impressive 37%.
There are plenty of other ETFs of this type to look at, and many of them have been performing incredibly well lately. The PIMCO 25+ Year Zero Coupon U.S. Treasury Index Exchange-Traded Fund shows a return of over 16% in the year to date, for instance.
Why Is Now the Time to Take Action?
As we have seen there are 2 big factors at play. The first is the stock market. When it is as nervous as it is just now, it makes sense to head into bonds. Many investors keep things steady with Treasury Bonds, but these zero-coupon options give you more earning potential in exchange for more risk expose.
If you think the stock markets will keep falling due to global political tensions and coronavirus, then this is a good alternative. The more stocks fall, the greater the return in bonds. With more and more investors moving out of stocks and into bonds, there is now a clear trend that makes them more attractive.
The other big factor is interest rates. If the Fed cuts rates and stock markets keep falling, it is the perfect scenario for this type of bonds. How likely is this to happen?
Well, there is growing pressure on the Federal Reserve to cut interest rates this year. President Donald Trump asked for this to happen last year and now the market is clamouring for it to happen.
Don’t forget that long-dated zero-coupon bonds react more sharply to change in interest rates.
This makes them riskier but also gives more profit potential.
This is a smart way to bet on the current economic climate staying the same for the foreseeable future. An ETF based on STRIPS will give you the possibility of turning the slow global economy and falling stock markets to your advantage.