Over the past few years, billions of investment dollars have poured into government and corporate bonds and bond-based mutual funds. The mutual fund industry has recorded that the bond market has absorbed more money than equities did at the height of the dot-com bubble in the year 2000. The bond market could be the next bubble.
Why did this happen? Bonds were perceived as a perfect safe haven against dreaded and volatile equities. In addition to the interest rate paid on bonds, you also received a significant capital gain as interest rates declined. Bonds were safe, secure, and they made money. What more could one ask for?
With interest rates stalled at historic lows, the risk of holding bonds has increased considerably. Bonds are currently paying interest rates that have not been seen since the 1940s. And bonds will not appreciate in value the same way they did during the declining interest rate environment that we saw over the past thirty years. In fact, the reverse is true. Bonds will decline in value when interest rates begin to rise.
There are two guarantees that can be made with absolute certainty for those of you who have participated in this bond-buying mania. The first is that you are guaranteed to lock in historic low rates of return on your bond investment. At the time of writing, the 10-year government of Canada bond was paying 1.82%. For the next ten years, this will be the return paid on this investment. Will this return be adequate to fund your retirement?
The second guarantee is that your bond values will decline when interest rates begin to rise. This is just the opposite of what occurred when rates were declining and you watched your bond values increase. This happens because bonds generate a fixed-income payment. So when market interest rates change, the market value of your bond with a fixed payment will change as well.
Here’s how it works from a simplistic point of view. As interest rates fall bond values rise. And conversely, as interest rates begin to rise bond values will fall. This is the risk and current danger of being over exposed to fixed income securities.
It doesn’t matter whether you are talking about individual bonds or bond-based mutual funds; the result is the same. You can no longer think of bonds as being your safety net. Rising interest rates will decrease the value of bonds. There is now great risk investing in bonds. The wise investor will be aware of these risks and adjust their investment plan accordingly.
The foregoing is for general information purposes and is the opinion of the writer. This information is not intended to provide personal advice including, without limitation, investment, financial, legal, accounting or tax advice. Please call or write to Rick Sutherland CLU, CFP, FDS, R.F.P., to discuss your particular circumstances or suggest a topic for future articles at 613-798-2421 or E-mail firstname.lastname@example.org. Mutual Funds provided through FundEX Investments Inc.