Bonds

Hello everybody,

I’ve been worrying about this for a while, so I thought I’ll just post my concerns and maybe it will be helpful to a few of you.  It’s important information and something that is vital to understand, so stick with me.

When the stock market started doing its nose dive in the Fall of 2008, many people (rightfully so) panicked.  As the stock market continued to plummet, some of you pulled everything out of the stock market, because truly, it felt like the end of the world.

Many of you, perhaps read some of the articles and saw the charts that were floating around, that showed that over the last 20 years bonds had outperformed the stock market by a pretty good margin. 

“Bonds!“ you thought.  “Safe and sound.“  So you went on-line, or you trotted down to your financial adviser and said.  “Put all that money, my retirement savings, my emergency fund, my kid’s education fund, into bonds.  I want to be safe and sound and apparently bonds are that very thing.“

Hold on a minute.

Not all bonds are created equal.  In the States there are municipal bonds.  On paper these seem like a no-brainer.  You get a higher interest rates than Government bonds and in many states, if you buy municipal bonds issued by that State, there are no taxes.  HOWEVER, it is VERY important to CHECK THE CREDIT RATING of your particular state.  Many cities and states are on the verge of insolvency and unless something big happens they might have to default on some of their obligations.  Not only that, but they, unlike the Fed. can’t print their own currency to pay off their debt.  So check carefully before you buy.  And if you have already bought, check anyway, as you can always sell, even if your bonds haven’t reached their expiry date.

With corporate bonds, you get a higher yield, but there is more risk.  You want to make sure that you (or your financial adviser) checks the credit rating, their solvency, their debt coming due, their cash balances.

Now, you might be saying to yourself, “Oh my, that all sounds very complicated.  Just put me in a bond fund and be done with it.“

YIKES! NOW WE COME TO THE MEAT OF MY WORRY.

I read a ton of financial material.  Many highly intelligent, respected financial experts are saying that the thirty year bull market in bonds is over. 

If that is the case, you DON’T want to be in long-term bonds, because you will be locked into a lower interest rate that won’t keep up with inflation.  I have noticed over the last few weeks that bond interest rates (and gold) have been on the rise.  Right now my bond ladder does not go out any further than 4 years, most of the maturities closer in.

AND EVEN MORE IMPORTANT:  If you want to be SAFE AND SOUND bond funds are NOT for you!  What many people don’t realize is that while owning your own bonds (if they are rated AA or AAA) means that it is pretty safe to assume that not only will you be receiving interest on your bond, BUT ALSO that when your bond matures, you will receive back the entire amount of money that you invested in the bond.  100 dollars in,100 dollars back.

With a bond fund that is NOT the case.  With a bond fund you own nothing tangible.  If the bond market dive bombs, so does your investment.  Bond funds can be very volatile things in a bond bear market, just like mutual funds are when the stock market is in a funk (or even sometimes when the market isn’t.)  And THAT is what I wanted to warn you about.

I kept picturing that some of you perhaps lost a lot of your savings and retirement money in the stock market nose dive, and worried that maybe you jumped out of the pan and possibly into the fire.  Just needed to warn those of you that perhaps didn’t understand the difference between bond funds and owning actual bonds.

Bond funds are not safe and sound.  If you are going to need that money anytime soon, and you need to make sure it’s all going to be there when you need it, you will want to be in GIC’s or T-bills.  But I wouldn’t recommend going out long-term as interest rates appear to be on the rise, and if you lock yourself into too low an interest rate, your money will lose purchasing power due to inflation.

Thanks for hanging in there with me.  I know this financial stuff is kind of boring, but it’s really important.  It’s your future and unfortunately many people don’t know the difference because no one has ever taken the time to explain it. 

With love, Meg

Posted by Meg Tilly on Sunday, April 11, 2010 in Chewing the Fat