There tends to be a lot of anxiety surrounding Treasury bonds. Many institutions and investors peg their hopes, dreams and fears around this one particular investment. I have never liked the idea that one’s investment allocation and strategy should revolve around any one piece of data.
Yes, interest rates affect Treasurys and they affect how some investments should be allocated, but it’s not the be-all, end-all. In addition, I don’t think any investor should carry very much in Treasurys these days. They pay almost nothing and they are worth less than nothing, because inflation eats away at their returns.
Bear Market in Bonds?
Still, investors are worried about the bond market. There’s a lot of uncertainty. When will today’s historically low interest rates rise? People have feared an interest rate increase for years – literally. Federal Reserve Chairwoman Janet Yellen recently remarked that, yes, the Fed plans to raise interest rates in September. In turn, we saw bonds sell off pretty harshly in the first half of the year.
Ack! Is this the start of a bear market in bonds? I mean, we have been at insanely low levels and been there for a long time. All good things must end.
Well, first of all, remember that the bond markets are not only far larger than the equity markets, but they simply do not crater like equity markets. You also must remember that as you receive interest payments from bonds at lower rates, you can re-invest them at higher rates.
If your bond value declines, you will also have some offset by the rising rates involved. In addition, as bonds mature, you can roll lower-rate bonds into higher-rate-paying bonds. Treasurys won’t default, so you’ll be safe there. You may experience negative returns, but not horribly negative returns, which is the risk with equities.
Some Options for Investors
So what should you do?
With the Fed contemplating raising interest rates in the near future, and a flatter anticipated yield curve, short-term bonds are going to be sensitive to either real or imagined (anticipated) rate hikes.
The speed, size and number of rate hikes are what really matters, less so the timing that of hikes. You can always dump your money into passive ETFs, but this is where it is worth ponying up a few dozen basis points for an active manager. They can move money more quickly, and respond to the changes rapidly. They can rotate in and out of various sectors, including Treasurys.
As I said, I hate short-term bonds anyway. They pay nothing. So now you actually have a reason to reduce any short-term bond holdings that you have.
Personally, I would move them to either exchange-traded debt or preferred stocks. These pay far more than most bonds and are of equal practical safety, if not as safe from a theoretical standpoint. Only if long-term rates rise another 2% to 2.5% do those investments start to get risky.
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