Beware of Bonds

By John Convery, CFA

.   Interest rates have been falling for more than thirty years.  That’s the same thing as saying that bond prices have been rising, so the track records of bond funds, pension plans, and all things “low risk” or “fixed income” have been terrific.  That’s about to change.

The prices of long-term bonds will fall more than the prices of short-term bonds, and they have a long way to fall.  In 1981 the yield on a 30 year US Treasury bond reached 16%, which means that a $1,000 bond paid annual interest of $160.  Those bonds became more and more valuable as interest rates declined;  new ones now pay just $32 a year, or 3.2%.

These are the lowest rates the country has seen since the Mayflower landed—pushed down to artificially-low levels by the Federal Reserve.  Eventually the yield on 30-year treasuries will rise from 3.2% to 7.2%, which means that the price of the bond will be cut in half.  Down 50%!!

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More wealth will be lost in bonds in the next few years than was lost in stocks in the financial crisis.

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­­­­­­­­­­­­­­­­­­­­­­­The really big danger will be the investments that seem too good to be true;  the kind that offer a good rate of interest and a guarantee that you can’t lose.  There’s always somebody on Wall Street who is willing to cook up can’t-resist financial products for a public that is unable to fully understand the dangers involved.

When the chickens hit the fan, Wall Street firms will insist that they fully informed their customers of the risks.  Do your own homework, and remember that investments which seem to be too good to be true are nearly always too good to be true.

 

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