There is practically universal opinion that interest rates will rise in the future, and that bond portfolios will suffer painful losses when this happens. At Merriman, we think the financial news media has blown this story way out of proportion, with inflammatory headlines designed to capture attention. Narratives include “the coming bloodbath for bond holders” and “the imminent bursting of the 30-year bond bubble.”
Our Chief Investment Officer, Dennis Tilley, recently wrote an article detailing three reasons why we’re not worried about rising interest rates. Here’s a quick summary:
1. The Experts and Consensus Are Often Wrong
History provides countless examples of when experts and/or a super-consensus have been wrong about the future of stock and bond movements. This is why we don’t use market predictions to manage client portfolios.
2. A Portfolio Duration of Four to Five Years Is Optimal
The sweet spot duration for Merriman investors holding bonds is in the maturity range of four to five years. This intermediate duration provides a nice compromise of offering overall portfolio stability, market crisis/deflation/recession protection, a long-term real return above inflation and – perhaps most importantly – the ability to quickly adapt to a rising-rate environment. With this duration, we believe our clients don’t have to worry about rising interest rates. The article provides more detail and charts illustrating this point.
3. Rising Rates Signal an Improving Economy
Finally, rising interest rates are likely to coincide with an economy that is improving, which is generally good for stocks. Yes, temporarily, bonds will lose value due to rising yields. However, we expect only single digit losses from our bond portfolio, not the “bloodbath” that some pundits seem to think will happen.
Editor’s Note: Below is an article published first at MarketWatch that was written by Elaine Scoggins, CERTIFIED FINANCIAL PLANNER(TM) and director at Merriman
Early in my career, I knew a wealthy man who took his own life. He left a suicide note saying he was pushed to the breaking point trying to pay back some sizeable business and personal debt.
From the outside, he appeared to have it all: a successful business, a beautiful new luxury home, expensive vacations and a wonderful, loving family. But, like with so many people we’re impressed by, no one knew about the dangerous levels of debt he’d taken on in order to have all those things.
I use this story knowing it is an extreme case. Debt, in the right amounts and at the right times in our lives, can be very beneficial in helping us get ahead. But if you get into a situation where you can’t pay it back, it can turn out to be one of the ugliest nightmares you’ll ever face.
You might think that if the lender says you’re fine to borrow the money, it must be OK to proceed. But there’s one gigantic problem with those income and debt ratios that are commonly used to screen us all before we borrow: They assume nothing in your life is going to change.
Taking the time to honestly answer these five questions could save you from years of misery.
As anyone who has recently refinanced a mortgage knows, interest rates are near historic lows. Low interest rates are good for borrowers, but not so good for lenders. This is important to remember because investors who buy and own bonds are lenders.
To help illuminate the risks and rewards of owning bonds, here are five key concepts that are worth keeping in mind. (more…)
I inherited a CD a few years ago which is coming due soon. It is worth about $54,000 and has paid a good interest rate that I don’t imagine I could match today. I need to reinvest this money in something relatively safe (I am 60 and can’t afford to lose the money). But I also want some growth potential because I won’t be retiring for another five years or so. What would you suggest?
There is no “right” answer to your question. It’s entirely a tradeoff between the safety you want and the return you want. Any attempt to achieve growth carries with it the risk of losing some of your principal. At the same time, if you try to avoid losing any principal, you won’t get much of a return and you could run the risk of losing purchasing power to inflation.
So how does one deal with this dilemma? First, be thankful that you have this money and that you have received decent interest on it.
Beyond that, your best guidance will come from looking at the time frame of your intended investment. (more…)
Here’s an article we recently mailed to Merriman clients, addressing some inflation questions that we felt our FundAdvice readers may also be interested in:
Some investors are concerned about the prospect of future inflation, based on fiscal and monetary measures the U.S. government has taken to respond to the recent market crisis. However, other metrics suggest that moderate inflation will continue. These include current inflation, bond market indicators and worldwide excess capacity.
Merriman’s recommended bond portfolio is structured to provide a reasonable level of protection against inflation.
The Fed’s view
The Federal Reserve, in a statement on April 28th said, “With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.”
Notwithstanding this reassuring if somewhat abstruse statement, there is considerable debate about whether higher inflation will result from the fiscal and monetary actions the federal government used to curtail the market plunge from October 2007 to March 2009. Inflation is the nemesis of bond investors. An increase in inflation will cause an increase in interest rates and decrease the value of bonds. Conversely, if interest rates were to fall because of lower inflation, bond prices would rise.
What factors impact inflation and how is our bond portfolio structured to handle inflation risk? (more…)
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