by Lance Wallach
Interest rates are at a 45-year low — great news, right?
Maybe not for all the investors who flocked to bond funds in light of what seemed to be a perpetually declining stock market.
Many investors are looking to the “more conservative” bond market as a vehicle for investing their retirement money. It sounds logical, but now may not be the right time.
Bonds are typically less volatile than stocks, but they still carry their own types of risk, such as inflation risk, prepayment risk and credit risk. The assumption that a bond fund is “safer” than the volatile stock market is a misconception — the bond market can perform as erratically as the stock market, especially during times of frequent interest rate movement.
In July 2003, bond mutual funds experienced their worst monthly loss in 16 years when rising interest rates caused bond prices to tumble.
Since, historically, interest rates and bond prices move in opposite directions, if interest rates rise, bond prices invariably fall.
Investors who purchased bond funds as a refuge from the declining stock market may soon be disappointed. Historically, as the country moves out of a recession, the Federal Reserve begins to raise interest rates in order to moderate the inflation that usually accompanies a strengthening economy.
Currently, interest rates are so low, the only place to go may be up ... and when rates go up, bond prices go down. What does that say for your bond mutual fund? If you need money in the short term, your bond fund may be worth less than you paid for it.
Typically, if stocks are up, then bonds are generally down. But you can never be totally sure about either, so how can you win?
One word — diversification.
Don’t put all of your eggs in one basket. Your portfolio should strike a comfortable balance between stock funds and bond funds. If your clients are the unfortunate investors who have traded their stock funds for bond funds, tell them to hold on.
It may be a bumpy ride.
Lance Wallach, CLU, ChFC, CIMC, speaks and writes extensively about VEBAs, 412(i) plans, estate planning, pension plans and tax reduction. Reach him at (516) 938-5007 or www.vebaplan.com.
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