Category Archives: Bonds

With rising interest rates, what to do about bonds.

With interest rates increasing investors are noticing that their bonds are not doing nearly as well as their stocks.  In fact many investors may have lost money on bonds this year.  For example, the typical tax exempt bond fund has lost between 4 – 5% year-to-date.  What should investors do about bonds when the likelihood of rising interest rates is high?

The October issue of Financial Planning magazine give us an insight into what happened in the past when interest rates rose.

During the five-year period from 1977 through 1981, the federal discount rate rose to 13.42% from 5.46%, an increase of nearly 800 basis points, or 145.8%. During that period, the five-year annualized return of U.S. T-bills was an impressive 9.84%.  But T-bills are short-term bonds.

But bonds did not fare nearly as well. The Barclays one- to five-year government/credit index had a five-year annualized return of 6.61%, while the intermediate government/credit index had a 5.63% annualized return. The long government/credit index got hammered amid the rising rates, and ended the five-year period with an annualized return of -0.77%. Finally, the aggregate bond index had a five-year annualized return of 3.05%.

As every investor should know, bonds go down in price when interest rates go up but that decline is offset by the interest paid on the bonds.  If an investment manager knows what he is doing and protects his portfolios by avoiding exposure to long-dated government bonds the results will be acceptable. An annualized return of 5.63% is quite good when rates are increasing.

But one important note: It does not seem prudent to avoid bonds entirely during periods of rising interest rates. Bonds are a vitally important part of a diversified portfolio containing a wide variety of asset classes – during all times and seasons. Rather than trying to decide whether to be in or out of bonds, the more relevant issue would seem to be whether to use short-duration or long-duration bonds.

This, of course, is consistent with a strategic approach to portfolio design. Rather than completely remove an asset class from a portfolio, advisors and clients would be well advised to thoughtfully modify the components of an asset class. To use a nautical metaphor, rather than swapping boats, we simply trim the sails.


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Stop worrying about the Federal Reserve

There are lots of people fixated on trying to figure out what the federal reserve is going to do with interest rates and when they are going to do it.  If you are a retail investor, you are not going to beat the professionals in that game, so stop trying.  Instead, let the pros handle it and relax by looking at the view from 30,000 feet.  Here’s what the bond experts at Oppenheimer are telling us in a messge titled Why Fed Watching Is Likely a Waste of Your Time

What to Remember for the Long Haul

For long-term investors, I believe there are essentially five important points to keep in mind.

1) Overall global economic growth is slow but most likely the worst is over. While there may be hiccups every so often, it is unlikely that we will revisit the financial abyss in the near-to-medium term.

2) Real interest rates are quite low. Over any reasonable investment horizon, they are going to go up. That is true irrespective of what the U.S. economy looks like this quarter or who the next Fed chair is.

3) Because interest rates are so low now, the likelihood that returns from any part of the bond market will get you to a comfortable retirement based on their real returns is virtually zero. You most likely have to have a significant portion of savings in assets that provide better real returns, albeit with greater risk.

4) That said, you can’t just put all your money in stocks. There will be future periods of equity underperformance. In order to make sure you don’t panic and go all cash at the worst point in the cycle, have some part of savings devoted to bond or bond-like instruments now. Even if they aren’t generating a lot of income, those investments may provide protection during equity downturns, which is as important.

5) Income, not price appreciation, is typically going to be a significant part of overall returns. Therefore, wherever you can, and whatever risks you are comfortable with, seek out income-generating investment options. As always, past performance does not guarantee future results.

Good advice.

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Interest Rates

10-year-yields-and-30-year-fixed-since-2008[1]  The graph at left shows how the interest rate on the benchmark 10 year has changed from January 2008 till today.

Note that the 30-year fixed rate mortgage tracks this almost perfectly because banks us the rate in the 10-year treasury bond to set the rate on fixed rate mortgages.

The rise in rates in the last year was triggered by the Federal Reserve’s hints that it would stop “easing” at some time in the future.  The recent announcement that it would not stop easing yet has caused the 10-year bond yield to decline from nearly 3% to about 2.65%.

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The bond market is anticipating a change in Fed policy

Via the First Trust Monday Morning Outlook.

While it certainly hasn’t made the headlines that it should have, the bond market has been kicked in the teeth.    After bottoming at  1.61%  on May 1, the yield on the 10-year Treasury Note hit 2.84% on Friday,  its  highest level in two years –  the worst bear market move in bonds since  the end of the 2008-09 financial panic.

This may well be the move in the bond market that we have been anticipating for some time.  It was utterly predictable and inevitable.   Having anticipated this move and positioned our portfolios appropriately, we will have to hang on for the ride as we have other market transitions.

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Good News: ‘The Sky is Falling’

Interesting commentary on the rise of interest rates and municipal bonds.  From the President of First Miami:

Have you heard the clucking?

It’s the sound of Chicken Little returning to the municipal bond market.

In 2008, he paid a visit during the mortgage crisis. At the time, bond insurers were downgraded when they strayed from their traditional market and ventured into exotic – and toxic – financial products, while major banks, brokerages and hedge funds, which traditionally provided support to the muni market, became net sellers to enhance their own liquidity during the tumult.

Munis themselves were fine, but the chickens clucked, bond prices slumped and too many average investors panicked and sold. Veteran bond investors, meantime, did what they always do: take advantage of the disruptions and feast on fatter yields.

Two years later, Chicken Little reappeared, this time in the guise of a banking analyst whose comments on state and local finances during a TV interview spooked investors and spurred a muni selloff. Nevermind that her warnings of Armageddon were wildly off the mark; many took heed and, as a result, blew a hole in their portfolios.

He’s back

Today, Chicken Little has returned, with the same, equity-oriented pundits warning of a calamitous interest-rate spike and urging investors to shed their bonds.

Which bonds are they referring to? We’re not sure, and due to their lack of expertise in bonds, they’re probably not either. We only hear about Treasury bonds, but we don’t know of a single individual investor who owns any.

Read the whole thing.

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Interest Rates On The Rise

From the First Trust Market Watch of Friday, June 21, 2013:

The yield on the 10-Year T-Note has risen from 2.13% as of last Friday’s close to 2.50% this morning. It is up 83 basis points since April 30. That is only 38 trading days. Since 1991, the average number of trading days it took for the yield on the 10-Year T-Note to rise 100 basis points (using 10 instances) was 80 trading days.  Goldman Sachs just released its yield targets for the 10-Year putting it at 2.50% at year-end, but then sees it climbing to 3.75% by the end of 2016, according to Barron’s.

As of today, the yield on the 10 year US Treasury note is 2.65%.

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Key Rates

  • LIBOR (1-month)  0.19%
  • Fed Funds  0.00-0.25%
  • 6-mo CD  0.40%
  • 1-yr CD  0.56%
  • 5-yr CD  1.23%
  • 2-yr T-Note  0.30%
  • 5-yr T-Note  1.02%
  • 10-yr T-Note  2.13%
  • 30-yr T-Bond  3.28%
  •  Prime Rate  3.25%
  • 30-yr Mortgage  4.10%
  • CPI – Headline  1.10%
  • CPI – Core  1.70%
  • Money Market Accts.  0.47%
  •  Money Market Funds  0.02%
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Advisors Should Warn Clients About Bond Risk

The Financial Regulatory Agency FINRA has expressed concern that clients may not be told about bond risk.

Finra, the brokerage industry self regulator, says advisors who fail to warn clients about the possibility of a bond bust could face regulatory problems, reports Reuters.

As the economy recovers, the value of bonds — sought out in recent years for their relative safety — could plunge as interest rates rise. At Finra’s annual conference last week, its chairman and chief executive, Richard Ketchum, said now is a “great time” for brokers to talk to clients about the potential risks of bond holdings because “it is clear that interest rates have far more room to go up than down.”

Bond risk as it involves the risk of bonds declining in price when interest rates go up is not well understood by the investing public who believe that bonds are safe.  They are not.  Because interest rates have been going down for over 30 years, many people have not experienced the risk to their bond portfolios that occur when rates begin to go up.  It’s one of the reasons that an experienced RIA can help people avoid financial traps like “bond risk.”

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The “Dow” at record levels


The Dow Jones Industrial Average continues its relentless climb to record levels.  Should we be worried?  Here are a few factors to take into consideration.

  • Employment is getting better.  Hiring is not robust and many are still unemployed or underemployed, but the trend is modestly up.
  • Retailers are feeling the pinch as take-home pay gets cut from the social security tax going back to the historical 6.2% rate.
  • Home prices are stabilizing and are even reported to be increasing in some areas.
  • The banks are making lots of money; borrowing at 0% and lending at 10% allows them to rebuild their balance sheets.
  • Corporate profits are hitting record levels.
  • Watch out for bonds.  When the Fed allows rates to rise to more normal levels, bond prices will decline.
  • Stocks are more attractive than bonds for many investors looking for income as dividends often exceed the yield on bonds.  There will be fluctuation as economic and political roadbumps are hit; remain well diversified.
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What’s the hurry? Financial decisions that can wait


From Reuters we get some ideas that can be better if you procrastinate.  Here are some things that get better if you wait.

— Transferring from a traditional individual retirement account to a Roth IRA. When you move money from a tax-deferred IRA to a Roth, you have to pay income taxes on the amount you move. If you do that at mid-career, you’re likely to be paying at a top tax rate, and perhaps even limiting the amount of new money you can invest while you pay taxes.

COMMENT: If you wait until after retiring, you may be in a lower tax bracket.  But there are no guarantees since tax rates are on the rise.

— Buying TIPS. Treasury inflation protected securities … If you wanted to sell TIPS before maturity, you’d get less back than you paid for them.

COMMENT: That’s mostly true because TIPS prices have been bid up to extraordinary levels.

— Buying a fixed annuity.

COMMENT: Rates today are at a record low.  And, by the way, the older you are the higher the income from a fixed annuity.

— Paying off that mortgage

COMMENT: At today’s low, low interest rates you may be able to invest and make a higher rate of return on your money than the interest on your mortgage.  On the other hand, not having a mortgage payment frees up a lot of cash, and many people prefer to know that they, rather than the bank, own their home. 

— Buying the new car.

COMMENT: A car is a depreciating asset.  The writer suggests taking a trip instead, spending money on experiences, instead of things.  Good advice.  At one time, 100,000 miles was the limit for any car.  Today, many cars are good for another 50, 100 or 150,000 more miles.  The time to replace a car is when maintenance costs begin to mount.


Wondering what to do and when to do it?  Contact us.

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