Many investors focus on past returns when making investment decisions. Our personal experiences – particularly recent losses or missed opportunities – can weigh heavily on how we approach risk and outlook. This is known as recency bias. However, when it comes to fixed income, especially municipal bonds, the landscape has changed and may offer more compelling value than many realize.
After years of ultra-low interest rates, the market experienced a sharp market reset in 2022. As a result, bond market returns suffered, especially when compared to those of equities and other risk assets. It’s very important for investors to remember that markets are evolving, and today’s bond market is no longer the one of the past decade. Yields have risen; the curve has recently steepened; and tax advantages for municipal bonds remain a powerful tool for high-income investors. The real risk may not be price volatility but rather missed opportunities due to misaligned allocations.
As writer and politician Roy T. Bennett once said, “The past is a place of reference, not residence.” In that spirit, investors who are open to the evolving realities of today’s fixed-income environment may uncover new opportunities for income, diversification, and tax efficiency.
A hidden source of value
For investors in top federal and state brackets, the value of municipal bonds may be most apparent when looking at tax-equivalent yields. A 30-year high-grade AA general-obligation municipal bond yielding 4.93% as of July 1, 2025, delivers a tax-equivalent yield of 7.83% for investors in the highest federal bracket. This does not take into account potential state tax benefits. For example, if this bond is issued in New York, it can deliver upwards of 9.46% for a New York resident – showcasing the extra benefit of in-state municipal bonds for residents of high-tax states. That compares quite favorably to taxable alternatives, especially when accounting for a AA-credit-quality investment and portfolio diversification benefits.
Municipal bonds tend to have lower correlations to equity markets than many other investments do, offering a counterbalance to more volatile assets. They provide a steady income stream and, when managed thoughtfully in a diversified portfolio, may provide capital appreciation opportunities in a supportive rate environment.
Rethinking portfolio structure
Investors often purchase equities and risk assets with no maturity or return of principal at all, but scoff at bonds with maturities of 20 or 30 years. However, as is the case with other assets, bonds are often traded in the secondary market to enhance total return and realign portfolios for outlook. Frequently, they are not held to maturity. Bonds appreciate and depreciate in value during their holding period dependent on a number of factors, such as changes in overall interest rates. As interest rates go down, bond prices go up and vice versa. Thus, investments into fixed income at attractive entry points may provide opportunities for both steady income and capital appreciation opportunities during the investment.
Today, some investors still favor short-term bonds, preferring bond ladders or mutual funds concentrated in the front end of the curve, because of previous market volatility or wariness over inflation and government debt. This approach has been popular and carries a lower risk/return profile – but it may now be limiting. If the Federal Reserve begins to lower rates – something many economists anticipate may start in fall or winter 2025 – reinvestment risk may become a growing concern for portfolios concentrated on the short end. For investors who have a risk tolerance allowing for additional duration in their portfolios, the yield curve offers more compensation when incorporating longer maturities. Taking a broader approach may help improve after-tax income.
Building exposure across the full maturity spectrum can help reduce reinvestment risk, smooth out volatility, and increase long-term income potential. It’s not about making drastic changes; it’s just considering whether portfolios still reflect today’s environment or remain anchored in yesterday’s assumptions.
Questions worth asking
As you reflect on your fixed-income allocation, here are a few considerations:
· Are you relying too heavily on past returns to guide current allocation decisions?
· Are your bonds positioned only on the short end of the curve – and if so, how might that expose you to reinvestment risk, especially in a Fed cutting cycle?
· Are you positioned to benefit from the current yield environment over the long term?
· Does your fixed-income manager offer full-curve management, or stay intermediate and short?
· Are you fully utilizing the tax benefits municipal bonds could offer, especially in your state of residence?
· Are mutual funds, ETFs, or separately managed portfolios with individual bonds the most efficient way to invest, customize your portfolio, mitigate tax loss, and ensure transparency? Would you like to discuss the pro/cons of these investment options?
Looking ahead, not behind
There’s no denying that fixed income has had a difficult decade. However, the market has reset yields higher, and today’s market may offer a different opportunity set – one that rewards a more proactive, tax-aware approach.
Fixed income is, at its core, about stability, income, and efficiency. If those priorities resonate with your financial goals, this may be a time to revisit your bond allocation and position it for what lies ahead. The market changes – allocations should as well.
Benjamin Pease is Managing Director of Asset Management and Chief Innovation Officer for Cumberland Advisors. He leads the asset management business line with responsibility for leading strategic growth objectives.
