Private Advisory Group

Will someone please tell me when bonds become the Next Big Thing?

Posted by Steve

In the first ten months of 2009, investors plowed $313 billion more into bond funds than they took out … that’s a staggering shift in the investing market considering that over the same time investors also withdrew about as much money as they put into their stock funds. In a remarkably short period, a good many of the bond funds are now yielding around half what they did just a year ago.

We understand that many investors, scared by the realities of the economic market woes and fears of losing their nest eggs, are just looking for some safety. Bonds, the once dull and staid investment product, are now being heavily advertised as the safe refuge for your money. Investors have also gotten a huge push from the financial industry lately as everyone started touting diversification through bonds right after the latest crash and bonds have continued to be pitched – even as bond yields are flattening out or dropping.

We’re not opposed to bonds as a whole, they have their place in many well-considered, diversified financial portfolios. What we are concerned about is the lemming-like about face investors seem to have taken toward stocks and we believe that many investors are being lured into some pretty bleak investments simply for the sake of ensuring a risk-free portfolio.

We’re also concerned with a few facts that are not well known by many investors. The first of which is that while returns on any corporate, municipal, or Treasury bond looks better than say a bank account, it’s important to understand that many bonds these days are carrying a lot more risk. Plus, when investment professionals look at the frenzied buying on the bond market and the high demand for fixed income, it starts to look a lot like a bubble.

A bust in the bond market isn’t as obvious as a stock-market crash, but it could still have a nasty effect on investor’s nest eggs. If interest rates are to rise, for example and many analysts believe that’s likely, bond prices could suffer. Even prices on so-called ’safe’ Treasury and municipal bonds could fall 30 percent or more if interest rates slip higher in the next few years. It’s important to understand that bonds are not the end of all investor risk – even with government funds, investors can still lose money in bonds.

Of course, if a bond’s price falls, the investor can choose to simply hold and collect the interest it pays and wait. Doing so could mean holding a bond for years, perhaps even decades. While a 4.7 percent annual interest on a current 20-year Treasury bond looks good right now when compared with a CD, it will seem ridiculous if interest rates rise and banks start to offer 7 percent CDs. Then, you could be stuck with a bond that doesn’t mature for a decade more and earning the lesser rate.

Still, the perceived safety of bonds and bond funds is a powerful draw for investors who’ve really been tossed around and shaken lately. If rushing willy-nilly into the bond market isn’t the answer, what is?

A well diversified portfolio is always the answer. Every investor’s portfolio should be unique to their age, their financial goals, their wealth status, and their current earning power, so each investor’s portfolio is as different as they are and it changes as you change. At Private Advisory Group, we want to help our clients manage their risk, and even a few of their fears, with a strong diversified portfolio that works for you.