Overlooked risk in Bonds.
The low interest rate environment that may have kept the financial system alive, but it really seriously hurt savers. I’m talking about real savers, not investors. People who place money in the banks every month trusting that at the end of their working life, they will have a comfortable retirement.
Last checked, you will get less than 1% on a 1 year fixed-deposit and that is for a minimum amount of around $10,000. With inflation at above 4% the last 2 years, many people who worked so hard to save money are desperate for yields now.
Is it any wonder that bonds and bond funds performed so well this year? Globally, investors sank over $40 billion into bond funds in August, an all-time high for a single month, and are on pace to break that record again in September. For this reason, Stocks Likely to Catch Up With Corporate Bonds
A few important points to note.
Remember, rising rates mean falling bond prices. And rates can only go up frm here. Short-term bonds and money-market funds with three to six-month average maturities minimize the danger of losses if rates rise. Intermediate-term and junk-bond funds are exposed to much greater risk from rising rates and falling credit quality. When interest rates go up, investors in longer-term bonds can get slaughtered.
Bonds are safer than stocks. But, at today’s high prices and low yields, bonds are riskier than they were a few months ago. The way to tell is by looking at duration: the change in a bond’s price when interest rates go up or down by one percentage point. For example, a bond has a duration of 4, then its value will go up about 4% if interest rates fall by 1%; the bond will lose about 4% if rates rise by 1%.
Duration generally rises in tandem with bond prices, meaning that bonds are now primed to lose even more money if interest rates go up. The rising durations reflect the huge gains in the bond market this year. Municipal bonds have returned 15%, corporate issues almost 17% and junk bonds at least 25%.
The riskiest bonds of all right now are Treasurys. Unlike corporates or municipals, can’t gain from an improving economy. If the economy improves and interest rates rise, Treasurys will get hammered. The longer the bond, the harder the hammering.
Rising rates also will hurt corporate bonds, but an improving economy should improve sentiments to them, which will lessen your losses.
Thus, if you can’t stand the pain of fixed-deposit and money-market fund that offers no gain, your best bet is a short-term fund that has significant holdings of corporate bonds. A sensible choice: United SGD Fund, which can yields above 2.5% and has a short duration. Whatever you do, do not chase bond yield.
Leave a Reply
