The Great American Bond Bubble

This is the headline of a Wall Street Journal opinion article published on August 18, 2010, which echoes a theme that I have written about on numerous occasions.

The opinion column compares the current bond market to the technology stock market bubble that was experienced 10 years ago. The authors state: “a similar bubble is expanding today that may have far more serious consequences for investors.”

As interest rates have dropped to historic lows, investors in bond funds, or those who do not hold their bonds until maturity, will face significant losses, if and when interest rates rise. ” Those who are now crowding into bonds and bond funds are courting disaster… the possibility of substantial capital losses on bonds loom large… if interest rates rise to 4% (on a 10-year bond, which is currently at 2.8%), the capital loss will be more than three times the current yield.” That would mean that an investor would lose over 8.5% of their capital, for what was intended to be a safe investment.

We have recommended numerous times in this blog, that a fixed income portfolio is an important foundation of a client’s overall portfolio. We feel that a fixed income portfolio should generally be holding short-term individual securities, of a very high credit rating or FDIC insured.

The Investment Company Institute reports that from January, 2008 through June, 2010, outflows from stock funds totaled $232 billion, while bond funds have seen tremendous inflows, of $559 billion. Investors have reacted in this manner, as a flight to safety. However, we feel that these same investors will, at some point in the next number of years, be incurring huge losses that they currently do not foresee and do not understand.

In our role as an adviser, our goal is to provide clarity and insights, so that our clients will have a greater sense of security. While we cannot predict exactly when interest rates will rise, we do know that how we are structuring our clients fixed income portfolios are properly anticipating an eventual increase in interest rates. Our clients should not incur the tremendous losses that the authors of this article are forecasting.

If you are not currently a client of our firm, we would be pleased to review your fixed income portfolio, to see if this very serious issue applies to your situation. Please contact us to discuss this further.

Source: “The Great American Bond Bubble,” Wall Street Journal, August 18, 2010

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