Changes in Bond Yields

Created on Sunday, 14 June 2015 19:00

June, 2015

The recent increase in bond yields and the likelihood that the Federal Reserve will begin raising its target rate later this year have elevated investor concerns. Many investors are wondering if this is the beginning of a continued increase in yields and, if so, how it will affect their bond portfolios. From the end of January, the benchmark 10-year Treasury rate increased from a low of 1.64 percent to 2.37 percent in mid-June. While this rate is still low from a historical perspective, it is a fairly large increase for a short time frame.

Reasons for the Recent Increase

The Federal Open Market Committee (FOMC) has had a very accommodative monetary policy to help boost the economy out of the deep recession. It has held short-term rates near zero for almost seven years. We are, however, beginning to see signs of sustained improvements in economic data. New jobs numbers have come in better than expected. Nonfarm payroll employment has exceeded the 200,000 threshold in 14 of the past 15 months. As U.S. inflation data stabilizes, it is expected we will begin to see a rise in the target rate later this year.

The U.S. is not alone when it comes to the recent increase in benchmark interest rates. Many European government bonds have witnessed the same rate increases. The German 10-year Bund hit a low of 0.07 percent on April 20. It has since increased to 0.90 percent in less than two months. Although it is still an extremely low rate, it is a dramatic increase for such a short time frame.

Is This the Beginning of a Sustained Rise in Yields?

We believe it is nearly impossible to forecast the direction of future interest rates. There are many factors that could cause rates to continue their ascent or to fall back to lower levels:

• As mentioned, it is expected that short-term rates will increase, but this does not mean there will be an increase of 25 basis points at every FOMC meeting. The increase could be gradual because the Fed does not want to increase rates too fast and risk slowing the recovery.
• Further, an increase in short-term yields does not mean that all points of the yield curve will increase at the same rate. Short-term rates could increase at a rate greater than longer-term rates, causing a flattening of the yield curve.
• The current yield curve has already priced in an increase in rates. Investors are being compensated with higher yields for extending maturities. The question we do not know: Will yields increase faster (or slower) than what has already been priced into today’s market?

What Has Been the Effect on Bond Returns?

When interest rates go up, bond prices go down. For the first month of the year, bond yields had a fairly dramatic descent. The 10-year Treasury fell from 2.17 on December 31 to 1.64 percent at the end of January. This was good for bond prices. Since then, rates have jumped; the 10-year Treasury sat at

2.37 percent in mid-June. While this is a big jump from the January low, it is hardly a significant change from the start of the year. This places the year-to-date returns on bond indices nearly flat. The Barclay’s Capital Short and Intermediate-Term Treasury Index are still up for the year at 0.46 and 0.39 percent, respectively. The Barclay’s 5-Year Muni index is down just 0.02 percent year to date.

Our Message Has Not Changed

For investors who have followed our general guidance to use short- to intermediate-term high-quality bonds and bond funds, there is a positive side to higher interest rates. Higher interest rates mean the bond returns you expect to earn are higher now than they were. For investors with a long-term horizon, this is a plus.

Investors must also keep their total portfolio in perspective. While bond returns are flat to slightly negative for the year, the global equity market was up 5.3 percent through June 11 (as measured by the MSCI World Index). Because one of the key concepts behind diversification is having investments that have low correlations to others, this again shows the benefits of having a well-devised approach to building diversified portfolios.

Copyright © 2015, The BAM ALLIANCE. This material and any opinions contained are derived from sources believed to be reliable, but its accuracy and the opinions based thereon are not guaranteed. The content of this publication is for general information only and is not intended to serve as specific financial, accounting or tax advice. To be distributed only by a Registered Investment Advisor firm. Information regarding references to third-party sites: Referenced third-party sites are not under our control, and we are not responsible for the contents of any linked site or any link contained in a linked site, or any changes or updates to such sites. Any link provided to you is only as a convenience, and the inclusion of any link does not imply our endorsement of the site.

With Short-Term Goals, Go for a Bird in the Hand

Created on Sunday, 14 June 2015 19:00

A friend of mine recently sold his house. It will be a few years before he’ll buy another one. Because the house was worth a lot more than what he and his wife owed the bank on their mortgage, they are now sitting on a pile of money and wondering what to do with it.

As we talked, the following became crystal clear:

• They will buy another house in three to five years.
• They don’t know exactly where it will be.
• This money has to be there when it comes time to buy.

I could make a pretty good case that this money isn’t money at all; it’s a deeply held set of feelings. To my friend and his wife, this money equals shelter. It has to be there when they need it.

So when he asked me how they should invest this money, my advice was easy. I told him that he can take exactly zero risk with it, which means putting the money in something like certificates of deposit from a few different banks.

He understood my reasoning on a theoretical level. But when I told my friend he was likely to earn just about nothing on that money, things got interesting.

We work so hard to earn money. It almost kills us to think of our money not working for us. It feels morally wrong to let money just sit there doing nothing, like we’re unwise stewards. This is exactly how my friend felt.

But sometime, we need to let go of our focus on returns and shift our attention to safety. If we’ve mentally assigned money to goals just a few short years away, knowing that money will be there is more important than finding an extra percentage point.

Still, I understand the temptation to invest in the markets. What if stocks are poised to take off? What if we just heard some guru on a financial pornography network yelling, “We should all be buying the latest I.P.O!” What if our neighbor tells us that emerging markets will double our return?

To which I only have one reply: What if they’re wrong?

In a situation like this one, it’s helpful to recall and repeat Mark Twain’s advice to be more concerned with the return of our money than the return on our money. For things that are really important and less than five years away, like buying a house or taking a big trip, the return doesn’t matter. All we care about is making sure the money is there when the time comes.

So I’m over the idea that a big pile of money has to generate a big return. We could invest that money, but we’d also have to accept that three years from now, all the money might not be there. Any investment could come back later, but maybe not in time for the big, emotional goal we set. I’m betting at that moment, we’d feel even worse about less money or no money than no gain.

This commentary originally appeared May 26 on NYTimes.com

Copyright © 2015, The BAM ALLIANCE. This material and any opinions contained are derived from sources believed to be reliable, but its accuracy and the opinions based thereon are not guaranteed. The content of this publication is for general information only and is not intended to serve as specific financial, accounting or tax advice. To be distributed only by a Registered Investment Advisor firm. Information regarding references to third-party sites: Referenced third-party sites are not under our control, and we are not responsible for the contents of any linked site or any links contained in a linked site, or any changes or updates to such sites. Any link provided to you is only as a convenience, and the inclusion of any link does not imply our endorsement of the site.

An Investment Lifeboat Drill Now Can Help Weather Future Disaster

Created on Sunday, 07 June 2015 19:00

By Carl Richards

Calm water makes a lifeboat drill much easier. We aren’t fighting the waves or the fear we feel during an emergency. Still, if the worst happens, and the drill becomes reality, at least we’ve rehearsed. We’ll know exactly what we are supposed do.

With the markets relatively calm, now is the perfect time for an investor lifeboat drill. But to get the most out of this drill we need to remember how we felt seven years ago when the markets were getting scary.

Remember the days when even smart, reputable people shouted gloom and doom from the rooftops? If not (or if you’ve blocked it out), let me give you the abridged version: It was terrifying.

The United States government was bailing out private companies that were “too big to fail.” We were reading shocking headlines on a regular basis:

• Stocks Take Record Tumble, Down 777 Points
• For Stocks, Worst Single-Day Drop in Two Decades
• How Low Can The Stock Markets Go?

With those memories and emotions in mind, let’s start the first drill.

Take out a blank piece of paper. Grab two Sharpies, one red, one black. Write $250,000 in black in the upper left corner. Then, write $225,000 in the lower right corner. Use the red Sharpie to draw a down arrow from left to right to represent a market drop of 10 percent. How do you feel?

It’s probably feels a little uncomfortable, but you’re prepared. You’ve read about market corrections. During the last 70 years, markets have undergone 27 corrections. They aren’t unusual. You’ll buy stocks through the dip, perhaps through automated purchases through a retirement account.

For the second drill, pull out another piece of paper. Write $250,000 in the left corner and $200,000 in the right corner. Draw a scarier red arrow because now we’re talking about a loss of 20 percent.

Things are more serious at 20 percent. After all, market declines of 20 percent or more qualify as bear markets. But you’re still O.K. You’ll grit your teeth and continue to buy more stock at regular intervals because you believe Warren Buffett, who says you should be greedy when others are fearful.

The third drill will prove the most challenging. We’re going to focus on the “or more” part of the last drill. Think back to the market highs in 2007 and the market lows in 2009. The broad stock market index dropped over 50 percent. Write down those numbers on a third piece of paper. That’s $250,000 and $125,000. What will you do?

We know what many people did last time. They jumped overboard instead of getting into the lifeboat. History shows us the markets recovered. However, right at that moment, they just wanted the pain to stop, so they sold all their stocks.

I understand that this lifeboat drill seems academic, maybe even a little silly. Why do we need to think about what the markets might do? Sure, they’re not really doing anything right now. But that could change at any time.

To be clear, I’m not predicting a correction or stating that we’re in the midst of a bubble. I don’t appear on television often enough to predict something like that. Since 1945, however, we’ve averaged one correction every couple of years. We haven’t had a correction of 10 percent or more in roughly 43 months.

Even if we plan to buy through the next dip, no matter how big or small, we’re fools if we miss the opportunity to practice how we’ll react. The correction might only be a 10 percent decline. But it might be 40 percent. We don’t know, and that’s the point.

Don’t treat this exercise like the fire drill at work where only half the people leave the building. Give serious though to your investments. How would you react if any of your lifeboat drills became reality? Could you make yourself buy during a scary market?

Have a conversation with someone you trust, like your adviser or spouse or best friend, to talk through the options. Build a portfolio with a broad mix of investments that might help keep you from jumping overboard if they all don’t fall at once. If there’s even a possibility that you might have a hard time staying in the boat, now is the time to figure it out.

This commentary originally appeared May 18 on NYTimes.com

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The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

© 2015, The BAM ALLIANCE