However, bonds are traded and this means the price and yield moves. The yield’s the annual return as a percentage of the bond’s current price. And it moves inversely to price. As prices fall, yields rise, and vice-versa.

Generating a bond market second income

I believe that a carefully chosen portfolio of stocks is the best way to achieve financial success. In 2024, when my portfolio doubled in value, only a couple of my 25 or so holdings were bonds.

But currently, bond yields are elevated. This reflects the higher interest rate environment but also increased risk that government may not be able to service all their debts. But for those who believe this risk’s overplayed, the bond market’s full of opportunity.

To generate a £5,000 second income from a £100,000 portfolio, an investor needs an average yield of 5%. A diversified approach would mix different durations and geographies.

For example, US three-month Treasuries currently yield 4.36%, US 10-year Treasuries yield 4.45%, and US 30-year Treasuries yield 4.89%. Meanwhile, UK 10-year gilts yield about 4.2%. And South African 10-year government bonds offer a notably higher yield, recently around 10.3%.

A sample allocation might be £30,000 in US three-month Treasuries at 4.36%, £30,000 in US 10-year Treasuries at 4.45%, £20,000 in UK 10-year gilts at 4.2%, and £20,000 in South African 10-year bonds at 10.3%. This blend would generate about £1,308 from short-term Treasuries, £1,335 from US 10-year Treasuries, £840 from UK gilts, and £2,060 from South African bonds, totalling £5,543 before fees or taxes.

An easier option

Given these risks, a bond fund can be a sensible entry point. Funds like the iShares Core US Aggregate Bond ETF (NYSEMKT:AGG) offer broad diversification across maturities and sectors, reducing the impact of any single bond’s price movement.

The fund tracks the Bloomberg US Aggregate Bond Index and includes a mix of government, corporate, and mortgage-backed securities, with an average duration of about 6.5 years. It currently yields around 3.8%, providing a stable income stream while spreading risk across hundreds of bonds.

For investors wary of making a big bet on long-duration government debt, a diversified bond ETF like this one can offer a balanced approach, cushioning against volatility and policy surprises while still capturing attractive yields in today’s market.

However, it’s very US-focused. That may be a concern for some investors. It’s certainly worth considering however. I’m taking a closer look myself.

An even more diversified option would be Warren Buffett’s Berkshire Hathaway which has significant exposure to bonds and fixed-income instruments. Berkshire Hathaway’s now one of the largest holders of US Treasury bills, controlling nearly 5% of the entire short-term Treasury market. That’s about $314bn as of March. 

This vast position surpasses even the Federal Reserve’s Treasury bill holdings and reflects Buffett’s preference for safety and liquidity amid high equity valuations and economic uncertainty. This is one I’ve been buying, and I also believe it’s worth further research.

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That said, I believe a portfolio of well-chosen stocks is the best way to achieve long-term success in the stock market. For context, bonds made up a tiny proportion of my portfolio in 2024. But they have their place.

For those of us who are new to bonds, the yield works in a similar way to a company’s dividend. Each bond is issued with a coupon. This is the fixed annual interest payment — expressed as a percentage of the bond’s face value — that the issuer agrees to pay the bondholder until maturity.

However, bond prices move up and down like stocks. And the yield moves inversely to the price. That means when prices fall, yields rise, and vice versa.

So why do bond prices rise and fall? It’s essentially about risk. If bond market participants get concerned about a government or company’s ability to service debt (pay bondholders) then bond prices will likely fall.

Opportunity beckons in government bonds?

Right now, both US and UK government bond yields are elevated compared to most of the past decade. Higher interest rates are clearly part of the equation, but so is risk.

The US 10-year Treasury yield stands around 4.45%. That’s high by recent standards. It reflects concerns about persistent inflation, large government deficits, and uncertainty over the future path of interest rates.

Similarly, the UK 10-year gilt yield is hovering around 4.56%. Sticky inflation and fiscal worries are prompting investors to demand higher returns for holding government debt.

Where could I gain exposure?

Investors can simply buy individual bonds through their brokerages. Personally, I have some interest in short-duration bonds but none in the long end — government debt and deficits are too high.

So is this an unmissable opportunity? Maybe in some parts of the market, but not everywhere.

Another way to gain exposure is through considering an investment in iShares Core US Aggregate Bond ETF (NYSEMKT:AGG). It’s one of the most popular and widely-held bond ETFs, offering investors broad exposure to the total US investment-grade bond market.

Launched in 2003 and managed by BlackRock, the ETF tracks the Bloomberg US Aggregate Bond Index, which includes US Treasuries, government-related bonds, corporate bonds, mortgage- and asset-backed securities.

The fund uses a sampling approach to mirror the index’s performance and invests at least 80% of its assets in the underlying securities. With a low expense ratio of just 0.03%, iShares Core US Aggregate Bond ETF can be a cost-effective way to gain diversified fixed income exposure.

There are always risks, and this is no different. A US recession could really pull this ETF down. Likewise, pound appreciation or dollar weakness could make this investment an unprofitable one.

It currently has $125m in market assets and offers a 3.8% yield.

Likewise, investors may look to Berkshire Hathaway for bond market exposure. It doesn’t pay a dividend, but invests heavily in US bonds. Berkshire’s now one of the largest holders of US Treasury bills, with nearly 5% of the entire short-term Treasury market. That’s about $314bn as of March.

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