If you’re feeling safer — or even a bit superior — because so much of your retirement fund is in bonds (or bond funds) paying a nice yield, you might want to take a closer look.
Bond prices are falling sharply — all categories of bonds from corporate to municipal, from high quality to “junk” — and even longer term U.S. government bonds.
The announcement that the government wants to “Go Big” to bail out the economy by creating at least a trillion dollars to help individuals and small businesses gave a boost to the stock market. But the bond market looked out to the future and saw inflation on the distant horizon.
Couple that with concerns that some bond issuers won’t be able to pay the promised interest in a recessionary economy, and the selling started in a major way.
Some closed-end bond funds are down as much as 30 percent.
Just a month ago, on February 19th, I posted this column “Beware of Bonds.” It was directed to 40l(k) plan investors who thought they were “safe” from losses, because they were in bond funds.
I noted that bond funds have been stuffed with some of the lowest-rated (BBB) bonds because they offered the highest yields. That attracted investors’ money. But the column also pointed out that if a recession came along, many of these low rated companies might default on their interest payments or be downgraded, forcing the fund to sell the bonds. That would push bond fund prices down.
Well, it looks like we are having a recession that will be deeper than anything I imagined just a month ago. What will happen to the bonds of airline companies, retailers, energy companies as businesses shut down? Will they default? Will they stop paying interest? Will there be a government bailout? Who knows? But savvy investors are selling bonds in anticipation.
Even the 10-year Treasury bond, which last week dipped to a yield as low as 0.31 percent, quickly moved up to a yield of 1.07 percent, reflecting fear of future inflation because of all the new government spending, which will be funded by money creation.
The math is simple. When bond yields move up, prices move DOWN! After all, who wants to give you $1,000 for that 10-year Treasury bond you bought last week carrying an interest yield of less than half of one percent, when they could buy the same bond now, with twice the yield? Sell, and you lose principal. Hold, and you’re stuck with a low yield.
The pros are selling bonds, and bond funds now — before all those ordinary investors who thought bonds were “safe” have figured it out!
So, stop thinking that you’re “safe in bonds.” That’s just not the case. Bond fund prices can fall too, for the reasons listed above. The “safe” money alternative in your retirement plan is a money market fund if there is one, or a stable value fund, or a short-term U.S. government bond fund.
Stop watching the headline stock market numbers. Take a look inside your 40l(k) plan for the safe alternatives — as I suggested in this column three weeks ago.
A reminder — this is not the end of the world, or the markets. We will get through this. But not without some loss. The next big losses are coming in bond funds.
And that’s The Savage Truth.