Should you invest in bonds in 2025?

With the rise of micro-investing platforms, investing in assets such as equities and crypto has never been easier.

Young investors flocked to these high-risk, high-reward markets, often leaving fixed-income assets like bonds out of their portfolios.

In retrospect, this was likely a savvy approach; high-risk assets produced solid returns for much of this decade. Conversely, bonds-historically a safe bet-experienced steep losses during this period.

But now the market is changing, and the old rules and strategies are starting to make sense again.

As we look ahead to 2025, bonds appear ready for a comeback, and this time, new methods for accessing them are helping investors of all backgrounds get involved.

Here's why bonds could be a smart play for the year ahead.

Do bonds have high volatility?

For a stable asset, bonds have had a volatile few years.

Throughout the centuries, wealthy investors have relied on bonds to steady their portfolios, particularly in turbulent times. But as inflation and interest rates surged due to the COVID-19 pandemic's economic impact, bond values took a hit.

This culminated in the worst year on record for bonds in 2022, with the Bloomberg Aggregate Bond Index (the Agg)- a global bond market benchmark tracking over US$50 trillion - falling 11%.
To put this in perspective, the Agg has only fallen five times since 1976.

In Australia, bonds dropped over 9% in 2022, making even cash, a traditionally low-return asset, more profitable in comparison.

Now the economy looks different.

The Agg has returned an average of 2.25% over 2024 to September, modestly up from 2% increase the year before. And while that's not an eye-watering rate of return, bonds began to serve its function again in investor's portfolios.

Inflation has settled to 2.8% in Australia, its lowest since early 2021, and calls for interest rate cuts are getting louder.

Globally, economies like New Zealand, Canada, the UK, and the US have already begun easing rates, with the Reserve Bank of Australia (RBA) being seen as a laggard compared to its central bank peers.

With calmer markets and declining rates, the dust has settled, and 2025 is shaping up as a strong year for bonds.

What is the relationship between bonds and interest rates?

To see this opportunity, it helps to understand the inverse relationship between bonds and interest rates. Generally speaking, when rates go up, existing bonds lose value, and when rates fall, bond prices rise.

Here's why: Most bonds pay a fixed interest rate, so when new bonds come out with higher returns in a rising-rate environment, existing bonds locked in at lower rates look less attractive.

Their prices drop to compensate. But when rates fall, bonds with higher fixed rates become more valuable since they offer a better return than new, lower-rate bonds.

How do bonds work?

Suppose you bought a bond last year with a 4% fixed rate, earning $40 annually on a $1000 investment. If rates rise and new bonds offer 6%, your 4% bond looks less appealing, so its price may fall to about $940 to raise its effective yield closer to 6% when sold.

If rates drop and new bonds yield only 2%, demand for your 4% bond rises, pushing its price up to around $1060.

Even though the interest remains $40 guaranteed if held it to maturity, the bond's higher price adjusts its yield closer to the new, lower market rate.

With the likelihood of rate cuts in 2025, these dynamics suggest bonds may be ready for a comeback.

How can I invest in bonds?

One of the most exciting changes in the bond market today is how digital platforms are making bonds accessible to a broader audience.

Blossom, a micro-investing app, stands out in this movement, bringing bonds - traditionally reserved for high-net-worth individuals and institutions - within reach of everyday investors.

"At Blossom, we're seeing a healthy interest in fixed income, especially among young investors," says Blossom CEO Gaby Rosenberg, who, at only 24 years old, founded the platform to give Australians easy access to this asset class.

"It offers a dependable way to diversify while minimising exposure to market downturns."

Of course, there are many other well-regarded institutions, usually exchange-trade bond funds or managed funds, which give retail investors access to the bond market.

There are also many types of savings vehicles, such as property bonds or investment bonds, which operate in unique ways.

Bonds can be a complicated asset class so it's best to do your research and consult the experts.

Should you invest in bonds in 2025?

While falling interest rates might spell good news for most investors, before it happens, it might be the right time to take stock of your portfolio.

The world is changing, with the US presidential elections, climate change, and conflicts in the Middle East and Ukraine all presenting ongoing risks to investors.

No one knows what the stock market will do, nor when the next black swan event will come along and flip the script.

A diversified portfolio needs ballast - an effective way of balancing the risk and reward, and Rosenberg says bonds can be this safety net in turbulent markets.

"For many, fixed income will always be a part of their investment strategies, especially as interest rates continue to stabilise," she says.

"Its role in a diversified portfolio is not only about reducing volatility but also about ensuring investors are not overly exposed to any one asset class."

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