Q: I lost when the market crashed in ‘08, so I’m reluctant about stocks. Are bonds a relatively safe harbor? I’m close to retirement and worry about losing it all.
[julie gampp]
vice president, investments, Stifel, Nicolaus & Company, Incorporated, Member SIPC & NYSE
Many investors consider moving out of stocks and into bonds in the years leading up to retirement to avoid risk. While it’s true that bonds can be a great tool to generate income, and their values tend to be less volatile than stocks, investors should be aware that there are some risks. One of the most common is interest rate risk. Bond values move inversely with interest rates: when interest rates go up, bond prices go down. That may not be a big issue if you hold the bond until the maturity date, when you’ll receive the face value. Another risk is default/ credit risk. You should always consider the financial strength of the issuer to be sure the interest and principal can be paid. And there’s inflation risk. If your after-tax return isn’t keeping up with inflation, you’re losing purchasing power.
Regarding the losses you’ve seen in your account, yes, we’ve seen unprecedented market volatility, but diversified investors who have stayed on the roller coaster have been rewarded for their patience. If you left the market, you may consider re-entering slowly over six to 12 months. Diversification is the key to reducing volatility and risk. Talk to your financial adviser regarding your specific investment mix, because there are many factors to consider in addition to your age.
[maurice e. quiroga]
managing director/executive vice president, PNC Wealth Management
The U.S. Federal Reserve Bank recently implemented policies that saved the economy, but may have created an unsafe environment for bonds. The Fed cut rates to 0.25 percent and purchased trillions of dollars of fixed-income securities in an effort to keep rates low. The theory was that lower interest rates would lower the cost of borrowing. The cheaper it is to borrow, the more likely a consumer or business will borrow money and spend it, thus spurring economic activity. So, given historically low interest rates, many cash-strapped investors desperately sought out higher yields. Some found them in lower-quality bonds. These types of fixed-income investments once carried the name ‘junk bonds,’ but today they are more fashionably referred to as high-yield.
Investors discovered that bonds with longer maturities could provide higher yields too. Investors stretched yield to 15- or 20-year maturities. But complacent bond investors received a wake-up call last year, when the annual return on U.S. long-term Treasury bonds went negative. Typically, bonds with longer maturities have higher yields, but are more sensitive to interest-rate changes. The losses bond holders experienced in 2013 may occur again when the Fed raises interest rates, which I predict will be in the third quarter of 2015. Fixed-income investors need to be aware that bonds may not always be a safe investment.