Diversifying for Income: Core Building Blocks to Strengthen your Portfolio

Investors can explore opportunities in core government, high yield and municipal bonds to potentially improve their portfolios’ income generation, as well as gain exposure to a set of diverse, uncorrelated assets.

Income generation has become a primary driver of total returns for investors, with all-in yields for investment grade, for example, hovering around 5%. In our view, strategies across the fixed income offering are flexible and differentiated enough to suit investor appetites across the risk spectrum, with some also possessing robust, ‘safe-haven’ properties that provide support for portfolios as other asset classes wane.

Diversification and income generation: Why it matters now

Fixed income was historically viewed as a one-stop shop for diversifying wider portfolios, due to its general negative correlation with equity prices. This was most expressed through a traditional ‘60/40’ portfolio, consisting of 60% equities and 40% fixed income instruments. The negative correlation meant that equities would generate most outperformance during periods of positive economic momentum, while the fixed income portion would provide a degree of downside protection through downturns.

This has changed in recent times, and investors need to diversify not just with fixed income, but within fixed income. Correlations in traditionally harmonious bond markets have become increasingly decoupled in an era of higher rates and volatility; for example, return profiles in US and global aggregate indices have become increasingly disparate. In addition, income has become a key driver of fixed income returns in the past three years. This means it is imperative for investors to consider how to appropriately diversify their portfolios while also maximising income potential.

Here, we explore four different ways investors of various risk appetites can rethink their fixed income allocations with diversification and income optimisation in mind:

Exploring income and diversification across the fixed income universe

Core government bonds: Investments in developed market sovereign bonds such as US Treasuries can help give portfolios a solid underpinning of high-quality assets that may offer resilience in periods of uncertainty, potentially providing a source of returns as riskier assets underperform.

We believe the current environment also provides core bond investors with the additional opportunity of locking in higher starting yields rather than just downside protection and capital appreciation.
Investment grade corporate bonds: Holding bonds issued by high-quality corporates—known as investment grade bonds—can also assist in portfolio diversification. Blue-chip names with robust balance sheets and diverse business lines can provide investors not just with a steady stream of income supported by strong underlying fundamentals, but could also act as another form of ballast for a portfolio in times of stress. Long-dated notes in investment grade credit, for example, can appreciate in volatile times should interest rates come down in that period. The additional yield relative to sovereign debt can also increase the income component of returns, emphasizing the primary role carry has for fixed income investors in 2026.

Some assets within fixed income can also offer increased income opportunities as well as potential diversification, further along the risk spectrum:

Municipal bonds: Fixed income instruments issued by US states, cities and counties and other local government entities can also provide investors with compelling income opportunities. This in part stems from their relative tax efficiency; interest income from municipal bonds is generally exempt from federal taxes, and could also potentially be exempt from state and local taxes as well.¹ When factoring in the tax advantage, municipal bonds may offer more yield than other taxable alternatives. This income boost is also backed by the asset class’s relative stability, high credit quality and low default rates; between 1970–2024, for instance, 10-year annualized default rates for investment grade munis stood at just 0.01% compared with 0.22% for IG corporate bonds.² The difference was even more marked in the high yield space, with a 10-year annualized default rate of 0.69% for munis and 3.46% for corporates.³These qualities are complemented by the muni market’s potential diversification characteristics. Munis’ close relationship with the public sector means the bonds somewhat mirror the direction of Treasuries, making them a potential diversifier against movements in equities and lower-quality credit sectors.
High yield bonds: Corporate bonds below the investment grade threshold can offer even greater potential for investors seeking higher income levels. This comes at a time when the fundamental picture for the asset class has improved in recent years, despite investments in the space coming with additional risk given the assessed lower creditworthiness and lower-quality balance sheets. For example, the credit quality of the US high yield index is now more than 55% BB-rated compared with under 37% in March 2007.⁴

The current high yield environment could offer selective opportunities for active investors to take advantage of pockets of weakness, in our view. The recent selloff in the software space, for example, has been indiscriminate, with spreads in the sector widening significantly relative to the benchmark on AI concerns. We think this creates a window for active managers to pick up names facing relatively less AI disruption risk, such as mission-critical software providers, for instance, at relatively cheap valuations.

Fixed income asset classes offer a wider potential range of income levels, depending on investor preference Table presenting annualized default rates across municipal and corporate fixed income segments, showing lower default rates for investment-grade municipals versus corporates and higher default rates in high yield bonds across 1-, 5-, and 10-year periods spanning 1970–2024 (IG muni near 0–0.009%, IG corporate ~0.08%–0.216%, HY muni ~0.69%–1.18%, HY corporate ~3.46%–4.10%).

Table presenting annualized default rates across municipal and corporate fixed income segments, showing lower default rates for investment-grade municipals versus corporates and higher default rates in high yield bonds across 1-, 5-, and 10-year periods spanning 1970–2024 (IG muni near 0–0.009%, IG corporate ~0.08%–0.216%, HY muni ~0.69%–1.18%, HY corporate ~3.46%–4.10%).

Source: Goldman Sachs Asset Management and Moody’s as of December 31, 2024. This data covers the period from 1970–2024.

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¹https://www.msrb.org/Education/Municipal-Bond-Basics-0
²Moody’s Ratings, ‘US municipal bond default and recovery rates, 1970–2024’, Goldman Sachs Asset Management. As of August 4, 2025.
³Moody’s Ratings, ‘US municipal bond default and recovery rates, 1970–2024’, Goldman Sachs Asset Management. As of August 4, 2025.
⁴Bloomberg, As of March 31, 2026.

Author(s)

Sylvia Yeh

Global Head of Client Portfolio Management and Co-Head of Municipal Fixed Income

Alvaro Quiros Rubio

Global Head of Fixed Income ETF Portfolio Management

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Risk considerations and disclosures

Municipal securities are subject to credit/default risk and interest rate risk and may be more sensitive to adverse economic, business, political, environmental, or other developments if it invests a substantial portion of its assets in the bonds of similar projects or in particular types of municipal securities. While interest earned on municipal securities is generally not subject to federal tax, any interest earned on taxable municipal securities is fully taxable at the federal level and may be subject to tax at the state level.

Investments in fixed income securities are subject to the risks associated with debt securities generally, including credit, liquidity, interest rate, prepayment and extension risk. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline in the bond’s price. The value of securities with variable and floating interest rates are generally less sensitive to interest rate changes than securities with fixed interest rates. Variable and floating rate securities may decline in value if interest rates do not move as expected. Conversely, variable and floating rate securities will not generally rise in value if market interest rates decline. Credit risk is the risk that an issuer will default on payments of interest and principal. Credit risk is higher when investing in high yield bonds, also known as junk bonds. Prepayment risk is the risk that the issuer of a security may pay off principal more quickly than originally anticipated. Extension risk is the risk that the issuer of a security may pay off principal more slowly than originally anticipated. All fixed income investments may be worth less than their original cost upon redemption or maturity.

International securities may be more volatile and less liquid and are subject to the risks of adverse economic or political developments. International securities are subject to greater risk of loss as a result of, but not limited to, the following: inadequate regulations, volatile securities markets, adverse exchange rates, and social, political, military, regulatory, economic or environmental developments, or natural disasters.

The risk of foreign currency exchange rate fluctuations may cause the value of securities denominated in such foreign currency to decline in value. Currency exchange rates may fluctuate significantly over short periods of time. These risks may be more pronounced for investments in securities of issuers located in, or otherwise economically tied to, emerging countries. If applicable, investment techniques used to attempt to reduce the risk of currency movements (hedging), may not be effective. Hedging also involves additional risks associated with derivatives.

Investing in high-yield securities can be complex and involves a variety of risks and benefits. Non-investment grade fixed income securities and unrated securities of comparable credit quality (commonly known as “junk bonds”) are considered speculative and are subject to the increased risk of an issuer’s inability to meet principal and interest payment obligations. These securities may be subject to greater price volatility due to such factors as specific issuer developments, interest rate sensitivity, negative perceptions of the junk bond markets generally and less liquidity.

References to indices, benchmarks or other measures of relative market performance over a specified period of time are provided for your information only and do not imply that the portfolio will achieve similar results. The index composition may not reflect the manner in which a portfolio is constructed. While an adviser seeks to design a portfolio which reflects appropriate risk and return features, portfolio characteristics may deviate from those of the benchmark.

The portfolio risk management process includes an effort to monitor and manage risk, but does not imply low risk.

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Views and opinions expressed are for informational purposes only and do not constitute a recommendation by Goldman Sachs Asset Management to buy, sell, or hold any security. Views and opinions are current as of the date of this publication and may be subject to change, they should not be construed as investment advice.

Individual portfolio management teams for Goldman Sachs Asset Management may have views and opinions and/or make investment decisions that, in certain instances, may not always be consistent with the views and opinions expressed herein.

This material is provided for educational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities.

Diversification does not protect an investor from market risk and does not ensure a profit.

Past correlations are not indicative of future correlations, which may vary.

There is no guarantee that objectives will be met.

Economic and market forecasts presented herein reflect a series of assumptions and judgments as of the date of this presentation and are subject to change without notice. These forecasts do not take into account the specific investment objectives, restrictions, tax and financial situation or other needs of any specific client. Actual data will vary and may not be reflected here. These forecasts are subject to high levels of uncertainty that may affect actual performance. Accordingly, these forecasts should be viewed as merely representative of a broad range of possible outcomes. These forecasts are estimated, based on assumptions, and are subject to significant revision and may change materially as economic and market conditions change. Goldman Sachs has no obligation to provide updates or changes to these forecasts. Case studies and examples are for illustrative purposes only.

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Date of first use: May 26, 2026