Should You Invest in Bonds During Recession?

Bonds are units of debt issued by companies and governments as tradable assets. When you invest in them, you receive regular payments from the bond issuer once or twice annually. 

They can also help investors preserve capital, as they receive their initial investment back when the bond matures. 

But is it a good idea to invest in bonds during recession periods? 

Let’s discover how recessions affect bonds, whether to invest in these assets and how to manage them when recessions hit. We’ll also show you how Vinovest can help you invest in a reliable alternative - fine wine.

How Are Bonds Affected by a Recession?

There are two scenarios that signify a recession risk:

• The widespread decline in economic activity 
• Two consecutive quarters of negative GDP 

During an economic downturn, as part of its monetary policy, the government drops the federal funds rate. This is the benchmark interest rate on loans, bonds and savings accounts. 

The bond market is inversely correlated with the federal funds rate and short term interest rates. When interest rates drop during a recession, bond prices increase, and bond yields decrease. 

During periods of economic growth that follow a recession, interest rates start to increase. Bond prices go down, and bond investors receive higher yields. 

Which Bonds Perform Best In A Recession?

Not all bonds perform the same way during a recession. Let’s take a closer look at the bond market to discover which bond type makes the best investment.

• Federal Bonds issued by The Federal Reserve System
• Municipal Bonds issued by State and Local Governments
• Taxable Corporate Bonds issued by Private Companies

1. US Treasury Bond/ Federal Bonds

Federal bonds or US Treasury bonds are issued by the Federal Reserve System (made up of the central bank and monetary authority of the United States.)

Investors favor Treasury bonds during a recession because they’re considered to be a safe investment. 

Purchasing a bond issued by the Federal Reserve Bank means that you’re lending money to the US government. Since the Federal Reserve collects taxes, determines monetary policy, and prints money if necessary, there’s little to no risk of default on a Treasury bond. 

Note: The treasury yield is the interest rate paid on bonds by the Federal Reserve Bank. Tracking the treasury yield curve is usually a good way of predicting a recession. 

2. Municipal Bonds and TIPS 

State and local governments issue municipal government bond options and TIPS (Treasury Inflation Protected Securities.) 

These bonds leverage local taxing authority to offer investors a degree of security. However, they carry more risk than federal government bond options because they aren’t backed by the central bank. 

For example, during the great recession of 2008, there were fears about the breakdown of the global banking system. As a result, deflation occurred instead of inflation, and the price of TIPS declined. There were also fears that state and municipal finance systems would collapse, which negatively affected municipal bond prices. 

3. Taxable Corporate Bonds 

Another bond type to consider is taxable corporate bonds. These bonds offer greater yields than federal government and municipal bonds because they carry more risk. 

That’s why choosing high-quality corporate bonds is essential to mitigate these risks. 

Should You Invest in Bonds During Recession?

To decide whether to invest in bonds during a recession or not, let’s explore the benefits and risks.

Benefits of Investing in Bonds During Recession

Here are the two main benefits of investing in the bond financial market during recession:

• Provides a stable, fixed income source: During an economic downturn, bonds can provide a predictable fixed income stream.
• High demand: Bonds become more in demand than dividend stocks during a recession. This is because owning part of a company through the stock market is riskier than lending money with a bond. So an investor would rather invest in a fixed income bond than in the stock market. If bond prices rise, you can sell and make a profit on your initial investment.

Risks Associated with Investing in Bonds During Recession

During a recession, there are two significant risks to be aware of when investing in bonds:

• Highly indebted companies: A corporate bond usually poses a significant credit risk during a recession. Some corporations, particularly those with a lot of debt, may go bankrupt and shut down during a recession. In this case, the holder of the corporate bond issued by the now bankrupt company will lose their principal investment. 
• High yield bonds: High yield or junk bonds usually pay a higher yield and carry a higher credit risk because they are issued by municipalities or companies with a greater risk of defaulting. So during a recession, the price of high yield or junk bonds generally falls.

Next, let’s see the best strategy for managing bonds during a recession. 

How to Manage Bonds During A Recession 

If you already have bonds within your investment portfolio, understanding how to manage them is critical. 

There are three key things you should do:

• Review Bond Durations
• Opt For Mutual Funds That Invest In Bonds 
• Choose Quality, Not Quantity

1. Review Bond Durations

When the interest rate drops during a recession, the yields paid on bonds can decline. Because of this, some investors prefer to hold short-duration bonds that mature quicker than long-term bonds. With long-term bonds, you could potentially lose more money on your initial investment. 

A bond with a short term rate will usually pay lower yields than a longer term bond, but it will offer more liquidity. Although this may not be a concern during times of economic growth, during a recession, the liquidity of assets is an essential factor. 

2. Opt for Mutual Funds That Invest in Bonds

If you want to mitigate the risks associated with bonds, you could consider opting for a mutual fund that invests in various bonds (also known as bond funds.) A mutual fund offers investors diversification for a relatively small investment. 

Bond funds are actively managed by a bond manager or investment team that conducts economic research to only purchase high-rated bonds with lower default risk. They also consistently track the bond’s yield curve to avoid holding on to it too long. 

Note: The yield curve is used on a graph to plot bond yields having equal credit quality but differing maturity dates. The slope of the yield curve helps predict future performance. An inverted yield curve or yield curve inversion may signal a recession risk.

3. Choose Quality, Not Quantity

Although high risk assets usually promise higher yields, over time, the borrower may default on the bond or file for bankruptcy. In this case, you will lose your initial investment and no longer receive yields. 

That’s why it’s best to invest in fewer high-quality bonds. Although their initial purchase price is higher and yields lower, they are a better portfolio choice during recessions than several high risk assets. 

Other less risky investment opportunities include real estate, commodities, and consumer staples stocks.

However, if you’re an investor looking for a reliable alternative investment, why not consider fine wine?

A Reliable Investment Alternative During Recessions - Fine Wine

Bond prices and yield amounts can rise and fall sharply, but fine wine is a stable asset.

The fine wine market expanded even during the great recession of 2008 and the financial market turmoil of 2020. According to economic research, fine wine investments have an average annualized return of around 13.6% and sometimes even more.

Rare wines like Domaine de la Romanee-Conti regularly show growth of 150-200% over a five-year period. This remarkable growth is primarily due to the imbalance between demand and supply.

Only 1% of fine wines produced annually are investment-worthy, and since demand far exceeds supply, sourcing a rare bottle is difficult. 

Fortunately, Vinovest can help you get your hands on a coveted bottle. 

Vinovest is a leadingwine investment platform that helps you buy, store, and sell rare and authentic wines from around the world in a few clicks. 

Here’s how it works:

• Sign up.
• Fill in a short questionnaire to help determine your investment preferences.
• Fund your account with at least $1,000.
• Vinovest’s AI will curate the best investment recommendations for you.
• Watch your portfolio grow.

Investing Wisely During Recession

Investing in bonds during a recession can be tricky. You’ll need to consider your investment strategy carefully and monitor economic activity to avoid holding on to your investments too long. 

Additionally, as interest rates drop during a recession, the yields you receive from the bond will also decline. Fine wine has proven to be a much more stable investment, yielding impressive returns even during recessionary periods. 

So visit Vinovest’s website to discover how their team of master sommeliers can help you source, store, and sell investment-worthy wines today.