Boil and Bubble: Potential Bond Trouble

“Double, double. Toil and Trouble. Fire burn and cauldron bubble.” This is dialogue from Shakespeare’s play Macbeth. Translated into today’s vernacular, it could describe what many see as a bubble in today’s bond market.

 

[CLICK HERE to read the article, “Vanguard’s McNabb on Budget, Taxes and Bubble Risks,” at The Wall Street Journal, April 10, 2013.]

 

After all, bonds have enjoyed quite a run for 30 years, when interest rates began slowly declining from their record highs to today’s near record lows. Even though traditionally, bonds have typically served as a conservative allocation in an investor’s portfolio, they can pose higher risks in a rising interest rate environment.

 

[CLICK HERE to read the article, “The Big Bet on Rising Rates,” at Wealth Management, April 3, 2013.]

 

When you consider today’s low, low interest rates – an environment held stagnant by the Federal Reserve’s actions – the general feeling is that in the future rates can only go in one direction. Up. Up is a problem for bonds – particularly longer duration bonds that are more sensitive to changes in interest rates.

 

[CLICK HERE to read the article, “Bonds Most ‘Overbought’ In 55 Years, Loomis Sayles’s Fuss Says,” at Bloomberg.com, January 30, 2013.]

 

So what’s this bubble people are talking about? The Financial Industry Regulatory Authority (FINRA), a non-governmental agency that self-regulates brokerage firms, tries to protect investors with securities compliance procedures and by providing information to the public to make it aware of potential investment risks. Recently FINRA issued this warning about how interest rates can impact bonds:

 

“Currently, interest rates are hovering near historic lows. Many economists believe that interest rates are not likely to get much lower and will eventually rise. If that is true, then outstanding bonds, particularly those with a low interest rate and high duration may experience significant price drops as interest rates rise along the way. If you have money in a bond fund that holds primarily long-term bonds, expect the value of that fund to decline, perhaps significantly, when interest rates rise.”

 

[CLICK HERE to read the alert, “Duration – What an Interest Rate Hike Could Do to Your Bond Portfolio,” at FINRA.org, February 14, 2013.]

 

[CLICK HERE to view the video, “Bond bubble/bond cliff: How should you respond?,” at Vanguard, January 28, 2013.]

 

There are good reasons to invest in bonds but, depending on your objectives, there are also good alternatives that can generate income while managing the risk to your principal*. If you’d like to discuss fixed income vehicles and learn more about bond alternatives, please give us a call.

 

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