How to Build a Bond Portfolio

Despite some wide swings over the last few years, most bond yields still remain elevated. In fact, many bond yields have risen back toward the high end of their 20-year ranges, which may be welcome news for investors who may have wondered if they had missed the opportunity to earn attractive yields.

There may be some confusion regarding how to actually invest, given how large and complex the bond market is. Below we'll address four key points about bond investing, ranging from "how" to invest to "why now?"

These are two of the key reasons to own high-quality bond investments. Most bonds make semiannual interest payments that are known in advance based on a percent of the bond's par value. A missed interest payment generally triggers a default for the issuer, whereas stock dividend payments are discretionary and can be raised, lowered, or eliminated based on the outlook for the company. Defaults for highly rated investments tend to be rare, however; default risk is highest for investments with sub-investment-grade, or "junk," ratings.

Bonds also have fixed par values and maturity dates, so barring a default, investors who hold them to maturity know in advance what they are scheduled to receive and when.

Bond prices can still rise and fall in the secondary markets, which might catch investors off guard because bonds are often considered "safe" investments. Bonds have interest rate risk, so their prices can rise and fall with the changing interest rate environment, as the chart below illustrates.

Shown below is the price of a Treasury note that matured in August 2026. It was issued in August 2016 at its $1,000 par value—meaning it was a 10-year note when issued—and matured at its $1,000 par value. As you can see, it was a bumpy ride along the way, illustrating that even high-quality investments like U.S. Treasuries can experience ups and downs. Yet the Treasury note matured at its par value in August 2026, meaning the principal was preserved, while still paying 1.5% annually to bondholders. This example also highlights how much the bond investing landscape has changed—the fed funds rate was in the 0.25% to 0.5% range when this note was issued, hence the low starting yield.

Holding bonds to maturity can help investors "look through" any potential price changes, as those price increases and decreases are ultimately unrealized. Keep in mind that this illustration is for one individual bond. Bond mutual funds and exchange-traded funds (ETFs) generally don't have set maturity dates or par values, so there are additional considerations for investors when deciding what approach is most appropriate.

The bond market is large and complex, with different types of bonds with varying degrees of risk. It can be difficult to know where to even start.

We suggest most investors first focus on "core" bonds, or high-quality bonds, like U.S. Treasuries, certificates of deposit, agency mortgage-backed securities, investment-grade corporate and municipal bonds, as well as Treasury Inflation-Protected Securities. These generally have low to moderate credit risk, depending on the investment, and tend to offer more diversification benefits when combined with stocks in a portfolio compared to bond investments with more risk. Think of core bonds as the "ballast" to your portfolio. We suggest they make up the bulk of your fixed income holdings.

Over the past 10 years, U.S. Treasuries have had a very low correlation with the S&P 500^® Index, while other high-quality investments, like agency mortgage-backed securities, municipal bonds, and the Bloomberg U.S. Aggregate Bond Index, have had slightly higher but still relatively low correlations. Riskier investments at the bottom of the chart below have high correlations with U.S. stocks, so if the stock market is falling, it's likely that these investments are as well.

After building a base of core holdings, investors may consider adding "aggressive income" investments like those highlighted in the table below. These investments come with greater risks—like the risk of default—and any allocation should be in line with an investor's risk tolerance. These investments should always be considered as a complement to core bond holdings, not a substitute.

The higher yields that aggressive income investments offer may be tempting, but they come with more volatility and larger potential drawdowns. The chart below compares the average annualized total returns with the average annualized standard deviation (a measure of risk) between many fixed income asset classes. The Y axis represents the annualized total returns—the higher the dot, the higher the average return. But it also shows that higher returns tend to come with more risk, as the X axis illustrates. A higher standard deviation means more volatility, so investors reaching for higher-yielding investments need to be ready to ride out the ups and downs.

Riskier investments, like high-yield bonds and preferred securities, also tend to have higher correlations with stocks, so they don't provide many diversification benefits to an overall investment portfolio. A high correlation means that their total returns tend to move in the same direction as stock total returns. That can be a good thing when stock prices are rising, but when stocks are falling, they tend to fall as well.

The favorability of these riskier investments can depend on a number of factors, like the extra yield they offer over higher-quality investments like U.S. Treasuries, fundamental factors like the economic outlook, or corporate profit trends. For our most recent views on the fixed income markets, including asset classes we find more favorable or less favorable, please read the Schwab Market Insights.

High-yield corporate bonds have lower credit ratings and have historically had higher default rates than those with investment-grade ratings, so when the economic outlook deteriorates, they tend to underperform. Corporate profits tend to suffer in a slowing economic environment, meaning it could be more difficult for low-rated corporations to remain current on their interest payments or even repay a maturing bond. Long-term investors willing to ride out the ups and downs can still hold high-yield bonds (or bond funds) in moderation given their relatively high yields.

When yields hit their peak, they rarely stay there for a sustained period of time. The recent fluctuations in Treasury yields suggest that trend continues.

Over the last 30 years, the 10-year Treasury yield tended to fall once it hit its peak, and that trend appears to be intact today. After touching 5% in October 2023, the 10-year Treasury yield has whipsawed since then, falling as low as 3.6% in September 2024, and then finally rose above 5% in early October 2026, although it has retreated modestly since then.

With the steady rise seen in 2026, the 10-year Treasury yield is back near its post-financial crisis highs. In fact, the yield, near 5%, is close to the upper end of its 25-year range. To put the level of yields into context, the yield held below 3.75% and averaged just 2.25% from May 2010 until September 2022.

We still find that investors may be waiting for yields to move even higher before considering investing in bonds. Waiting for yields to rise even more is an attempt to time the market, which is something we rarely suggest for long-term investors. Just as we wouldn't suggest a stock investor wait for the market to bottom—potentially missing out on gains if the bottom already happened—we don't suggest investors wait for the perfect time to invest in bonds. Yields for high-quality investments are still near their highest levels in years, so we suggest investors take advantage by considering bonds today. Just as we highlighted the Schwab Market Insights for our views on our more or less favored asset classes, we also provide guidance on the average maturities we favor.

Bond ladders can still make sense for long-term investors, but keep in mind there can still be some volatility with individual bond prices in the secondary market.

When yields are high, bonds can offer meaningful income and may help protect a portfolio against stock market volatility. Waiting for the "best" time to invest can mean missing out on that income along the way. More importantly, the yields offered on many high-quality bond investments remain near their more than 20-year highs.

We suggest starting with high-quality "core" bonds, choosing average maturities that line up with your time horizon, and then considering some of the riskier investments, like high-yield bonds or preferred securities, depending on your risk tolerance and risk capacity.

There are a number of ways to invest in bonds: individual bonds, mutual funds, ETFs, or separately managed accounts. There are benefits, and drawbacks, of each approach, and it ultimately comes down to investor preferences.

Schwab clients may search for individual bonds that meet their investment objectives and investing time horizon. For investors considering bond funds, the Mutual Fund Select List or ETF Select List are two good places to consider. Separately managed accounts offer professional management, but investors actually own each individual bond.