Financially Speaking Podcast

"No Hiding Place? Unpleasesent thought: If Bonds revert to trend, bondholders will get hammered."

Published on July 5, 2013

One of the most profound business decisions I made for my practice was to ‘go paperless’.  It took quite an investment in technology and cultural change to make that work, but the payoff has been worth it.  Before that time I was ‘papered’, so when I found an article in a magazine or newspaper that was interesting, I would rip or cut it out and place it in a folder on my desk.  In my desk drawer today is little device made specifically to cut articles from newspapers or magazine – to make a clean cut.  But now I simply save digital copies, no more paper articles.

Today I found an old paper file in my desk.  The file was full of articles about the problems bond investors face when interest rates rise.  The title above is from Forbes magazine, the October 1, 2001 issue.  As I read through these old articles, it was like reading about where we are in 2013.  Interest rates are rising and are likely to rise in the coming years.  If so, it is going to be tough to make decent returns in bonds.

Interest rates have generally been declining since the early 1980s. When interest rates decline, then the price of bonds go up.  For nearly have our lifetime, bonds have provided rates far above their long-term trend; and they are safer than stocks.

During the last recession, interest rates are the lowest we have seen since we were born.  Ask anyone with a bank CD.  Rates can’t get any lower.  They could stay the same.  But recently we have the inevitable rise in interest rates.  Ask anyone with a bond mutual fund.  They lost money in the past few months.

Back in the summer of 2003, yield on the 10-year Treasury note went up from 3.1% to 4.4%.  In six weeks, investors who owned those notes lost nearly 10%.  Long-term bondholders lost even more.  The historical average 10-year bond yield is around 5%.  Currently they yield about 2.5%.

When these interest rates rise to their long-term trend lines, bond investors will get hammered.  And investors who got out of the stock market and put their savings into bonds will be staggered by the double-whammy of a stock market crash followed by interest risk.  They will feel like there is no place to hide.

 

Tags: interest rate risk; bond investors; investments

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