Slow Death vs. Fast Death in Bonds

There is one investment that has been considered the crème de la crème of safe investments since 1917 – when the US Government sold its first “Liberty Bonds.” Liberty Bonds helped to fund World War I, and were the predecessor to what we now know as U.S. Treasuries.

Owning U.S. bonds has long been considered both patriotic and a safe place to store your cash. After all, funding our government’s wars and roads makes us feel proud to be Americans. And historically, the government of our great country has been the premier borrower.

But that was the past.

What you need to know is that U.S. Treasuries are fraught with risk and the potential for sizable losses. I’ve been saying this a lot recently, and I’m saying it again today because this is so important. I simply don’t want you to be crushed by the coming bursting of the bond bubble.

Owning bonds – including “super safe” U.S. Treasuries – will lead to a world of pain.

That’s because your investment will die either a slow death or a fast death. Let me explain…

The slow death will occur if you own bonds like the 10-year U.S. Treasury that’s paying a 2.5% yield. This yield barely keeps pace with current inflation of 2 – 3%. Essentially you’re earning no money by investing in Treasuries today, and if inflation rises slightly you’ll be in the hole.

The same is true of many other low-yield fixed income investments, including foreign bonds, muni bonds, and even many corporate bonds.

The fast death for bond investments happens if interest rates start rising. Ben Bernanke’s mere threat of ending QE3 sent the yield on the 10-year Treasury rising 50% since May.

That sharp rise in yield has losses already piling up for bond investors. Just look at one of the biggest bond ETFs – the iShares 20 Year Treasury Bond (NYSE: TLT). That “super safe” bond ETF that invests ONLY in 20-year U.S. government bonds fell by 13% in two months.

U.S. Government Bond Fund Plunges 13%

Perhaps the most important thing to keep in mind is that these losses are just the start.

The yields on bonds are rising, and when they do, principle prices fall.  As we saw recently, yields have started increasing with just a few comments from the Fed Chairman.

Consider what might happen when Bernanke raises the prime rate on Federal funds from 0.25% today to a more reasonable 1% or 2%. It could happen sooner than you might think.

When that happens, the 13% losses experienced in the last two months will seem tiny.

The patriotic thing to do today is to sell your U.S. government bonds.

A far better investment is America’s best corporations.  After all, our country’s thriving economy was built on the backs of entrepreneurs and innovators who built thriving enterprises in our country’s capitalist system.

As always, you have an opportunity to buy the best of these companies on the stock market. And to sweeten the opportunity, you can do so today at historically reasonable valuations.

Happy 4th of July…I’ll be back on Monday, July 8th with your next issue of Income & Prosperity. Enjoy the long holiday weekend.

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