What changing rates and inflation could mean for the bonds in your portfolio, and the life they’re meant to support
By Dan Goldberg, CFA, CFP®, CAIA, Diversified Portfolios, Inc.
Key Takeaways:
· Why are we looking at bonds again now? Today’s higher yields have changed the math on bonds. Starting yields can tell us a lot about what returns may look like over the next several years, and with yields meaningfully higher than they’ve been for much of the past decade, we think bonds are worth another look.
· Is every bond index built the same way? Not necessarily. The most common one is becoming more Treasury heavy as the US deficit grows, so we look to source income from other areas of the bond market.
What do the deficit, inflation, and the Fed have to do with your portfolio, and with your life?
More than most people realize, and we’d like to walk through why.
We know the money in your portfolio isn’t just a number on a screen or headlines in the daily news. It’s your grandchild’s college fund, the big family cruise you’ve been planning, or the chance to finally redo the kitchen you’ve hated for 33 years.
So when interest rates and inflation dominate the headlines, we want to talk through the silver lining for your portfolio, not just for the broad economy.
Rising Rates: Why Interest Rates and Inflation are Higher in 2026
The combination of increasing cost of capital and stubbornly high inflation are moving interest rates higher…
- Global Tech Investment: Significant capital is being invested in AI infrastructure globally. Increased demand for capital is one of many factors that can influence borrowing costs and interest rates. Interest rates are literally how expensive money is, and the more competition for capital can drive up this rate. AI infrastructure also is also increasing demand for materials and energy.
- Global Trade and Energy: Tariffs, energy-market disruptions, and geopolitical uncertainty can affect inflation expectations and financial markets, which in turn may influence the yields investors demand from fixed-income investments.
- The Service Economy: Services represent a significant portion of commonly followed inflation measures. You see it every time you pay for daycare, get an oil change, or order a deli sandwich that costs nearly double what it did a few years ago.
Because inflation drives up the overall cost of money, interest rates across short, intermediate, and long maturities have risen to compensate investors. While higher prices at the grocery store or auto shop are frustrating, the resulting shift in interest rates make bonds more attractive than they’ve been in over a decade, thanks to today’s higher yields.
Related: The “AI” Economy and Your Portfolio
Why Bonds are Having a Moment
While a healthy allocation to bonds, as a counterweight to stocks, has always made sense for many of our clients, a bond fund yielding 1% was never going to deliver much of a return, no matter how you looked at it.
That math has changed… Bond yields are meaningfully higher than they were during much of the post-financial-crisis period, making bonds worth another look for investors whose goals and risk tolerance call for fixed-income exposure. For certain diversified bond portfolios, starting yield has historically been an important contributor to subsequent longer-term returns, although actual returns can differ due to changes in interest rates, credit conditions, portfolio holdings, and other factors.
Note: Higher starting yields may make high-quality bonds more attractive as part of an appropriately diversified portfolio. However, higher yields do not guarantee positive total returns, and bonds remain subject to risks, including market and credit risk.
Looking at Your Whole Picture
This shift is especially important for those of you moving from your working years into retirement. For some investors approaching retirement, a well-diversified portfolio may become an increasingly important source of income alongside Social Security, pensions, and other retirement resources. An all-stock portfolio might have a higher expected return, but it tends to come with more volatility and deeper drawdowns, a trade-off your plan may not need to take on.
For some investors, an appropriate allocation to bonds can help reduce overall portfolio volatility, which may make it easier to stay committed to a long-term financial plan during periods of stock-market uncertainty. They’re less likely to hesitate when it’s time to pull from the portfolio for the things they’ve been planning for. If the market is down 20% and you need to fund a big trip, selling stocks at those prices is painful. Maintaining an appropriate allocation to fixed income can provide another potential source of liquidity during periods of stock-market volatility. Depending on market conditions and your individual plan, that flexibility may reduce the need to sell stocks after a significant decline and may create opportunities to rebalance the portfolio.
Our goal is to help narrow the range of outcomes for your plan, and a healthy allocation to bonds is one of the clearer ways we can work toward that.
3 Common Misconceptions About Interest Rates and Inflation
Myth #1: “The Fed controls all interest rates.”
The Fed directly sets the rate for short-term cash, but longer-term interest rates are governed by global supply and demand, long-term economic growth, and inflation expectations. A Federal Reserve rate cut does not automatically mean mortgage rates or long-term bond yields will drop overnight. At the Federal Reserve meeting in July, the Fed did not raise the Federal Funds rate (cash rate), but longer-term bond yields rose following this meeting.
Myth #2: “You can predict where rates will go.”
No one can reliably predict interest rate movements, me included. I grew up on the world’s largest bond desk, and I never met a (well compensated) soul who could accurately predict where rates were headed. For years, housing brokers and media pundits have promised that lower refinancing rates were just around the corner, yet rates remained elevated. Rather than building a portfolio around a specific interest-rate forecast, we generally focus on constructing diversified fixed-income allocations based on each client’s objectives, time horizon, liquidity needs, and tolerance for risk. Depending on those factors, short- and intermediate-term bonds may play an important role.
Myth #3: “An index is always the smartest way to own bonds.”
The most common bond index, the Bloomberg U.S. Aggregate, weights each investment grade issuer by how much debt that issuer has outstanding. In practice, that means the index gives the largest weight to whichever borrower owes the most, which in this case is the U.S. government. As Treasury issuance increases, Treasuries can represent a larger share of the index. Because Treasuries may offer lower yields than some investment-grade credit and agency mortgage securities, we evaluate whether other fixed-income exposures may be appropriate, recognizing that higher yields generally come with different or additional risks.
We also evaluate high-quality corporate bonds and agency mortgage-backed securities, which may offer higher yields than comparable Treasuries in exchange for different and, in some cases, additional risks, including credit, prepayment, extension, and interest-rate risk. A government-backed mortgage can potentially out-yield a Treasury from that same government, and that’s the kind of detail we look to build into your bond portfolio on purpose, rather than owning the index by default. It’s our job to get the details right, and this nuance is something that has changed our bond portfolios in recent years.
Building a Resilient Path Forward
We like to say we fight for every basis point, and we take that seriously. Even relatively small differences in annual returns can compound into meaningful differences over a long investment horizon. The actual impact depends on factors including the starting portfolio value, investment period, contributions and withdrawals, taxes, fees, and actual investment performance.
Big banks are generally happy to have your cash sitting in a checking account earning next to nothing. We’d rather make sure your cash is working as hard as it reasonably can for you.
Sometimes I call it “boring you to success.” Bonds may not be exciting to watch, but the goal was never excitement. It’s giving you the confidence to live the life you’re planning for.
Interest rates and inflation aren’t going away as topics, and neither is our attention to how they affect your specific plan. If you’d like to revisit your bond allocation together, reach out to your advisor anytime.
And if you’re not yet working with Diversified Portfolios and would like a closer look at how your bonds, cash, and overall portfolio are positioned for today’s rates and inflation, we invite you to schedule a complimentary Financial MRI meeting. It’s a chance for us to look at your full financial picture together and talk through where opportunities may exist.
