Safety First - Old Peak Finance

Safety First

March 17, 2013

2013_safety first

Safety First

March 17, 2013

Bonds — supposedly the “boring” and “safe” part of your portfolio — have been on a 30-year tear. You could have made over 6.5% / year in Vanguard’s total US bond market fund since it launched in 1986 … high returns, apparently without high risk. But now, bond prices are near all-time highs, meaning yields are near all-time lows. What to do?

First, ask yourself … why buy bonds? The answer: protection in bad times. Yes, they should also provide some annual income. Otherwise you would keep everything in cash. But more than anything, bonds — unlike stocks — should have minimal downside.

During the worst 12-month period for investors over the last decade (Mar 2008 – Feb 2009), stock funds fell over 40% on average. If you had 1/3 of your money in bonds, your blended loss would have been closer to 25% … not pretty, but hopefully easier to sleep, and easier to avoid selling at the bottom.

With interest rates so low, investors are tempted to take more risk with bonds to “squeeze out” more return. That means buying ultra long-term bonds, junk bonds or other lower quality bonds offering higher interest rates. The problem: you’ll suffer large losses when interest rates rise. Don’t take that risk. Stick with higher quality, short and intermediate-term bonds. You’ll give up some return today. But when interest rates rise, the prices of these bonds won’t fall nearly as much, and you’ll start earning higher rates more quickly as the old bonds are replaced with new bonds.

Higher quality bonds are your cushion. They seem a bad deal now. When we have our next market hiccup, you’ll fall in love all over again.

This article is not intended to provide tax, legal, accounting, financial, or professional advice. Readers should seek advice from qualified professionals who can review their specific circumstances. Old Peak Finance endeavors to provide information that is accurate and current. However, we cannot guarantee that this information has not been outdated or otherwise rendered incorrect by new research, legislation, or other changes. Old Peak Finance has no liability or responsibility to any individual or entity with respect to losses or damages caused or alleged to be caused, directly or indirectly, by the information contained on this website.

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