Nervous Investors Get Chance to Bail Bonds
A lot of novice investors have just discovered that they lost money in bonds in the first quarter.
Fortunately, those same investors now are being given a gift by the market: The forces that caused the first-quarter losses have reversed, at least somewhat.
The upshot is, if you really don’t belong in bonds, you’re getting a chance to exit here without too much pain.
That’s not to say you should. But for many investors who late last year figured bonds were just a higher-yielding substitute for safe bank CDs, the first-quarter should be a wake-up call: Higher yield truly does mean higher risk.
Who lost money in bonds in the first quarter? On paper, just about everyone. Check out the results for bond mutual funds, which is where a lot of former CD holders have flocked:
* The typical fund that owns long-term U.S. Treasury and federal agency bonds lost 1.95% for the quarter, according to fund-tracker Lipper Analytical Services in New York. That figure represents “total return,” meaning that even after you collected your interest from the fund, you still were in the red because the value of your original investment dropped.
* Funds that own high-quality, long-term corporate bonds fell 1.52% for the quarter, on average.
* Even funds that stick with short-term Treasury securities, considered much less risky than longer-term bonds (10 years or more), were down 0.58% for the quarter.
To put those negative numbers in perspective, the average stock mutual fund slipped 0.17% for the quarter. And if you had merely left your cash in a money-market fund or in a bank CD, you’d have earned a positive 1%, or about one-quarter of the 4%-or-so annualized yield on those investments.
What happened to bonds is simply that some investors began to assume the economy is recovering. And that, they figured, must mean that demand for money will begin to grow, and thus that interest rates will rise.
So rather than accept, say, 6% on a bond, investors began to demand 7%, figuring that’s what the prevailing rate will be later in an economic recovery.
If you own old 6% bonds, you lost: The value of your investment fell, because nobody’s going to pay you full price for 6% bonds when they can buy new 7% bonds on the open market.
Lately, though, investors have changed their minds again. Interest rates have begun to drop as investors perceive that the economy isn’t recovering quickly after all. So 6% bonds begin to look better--and that means they’re recouping some of the value they lost on paper in the first quarter.
Where do these ups and downs leave bond owners? David Tisdale, principal at money management firm Starbuck, Tisdale & Associates in Santa Barbara, says the question investors have to keep asking is simply, “Why do I own bonds in the first place?”
For many investors who need income, bonds yielding 6% to 8% seemed to make a lot more sense than bank CDs paying 3% to 4% at the end of 1991. You can argue that that’s still the case, because rates haven’t moved that much overall.
Yes, the first quarter hurt. Yes, a bond you bought for $10,000 may only be worth $9,800 on paper now--if you chose to sell it. But when you take into account the 6% to 8% you’ll earn in interest for the full year, the only way you could lose money in bonds for the entire year is if market interest rates keep moving up, causing your bond’s paper value to keep moving down. And the chances of that seem very remote.
Instead, most bond experts say that while rates are likely to jump around in a fairly narrow range all year as the economy twists and turns, ultimately a slow recovery should ensure that we’re not going back to super-high interest rates soon.
In the short run, though, the market’s emotions can cause plenty of anguish. “None of us are going to be very good at calling this quarter by quarter,” admits Donald Straszheim, chief economist at Merrill Lynch & Co. in New York.
But he adds, “I think there’s just as good a chance that the 2% you lost (on the typical bond fund) in the first quarter you make up in the second quarter,” as the economy remains slow and investors drop their fears of a growth boom and the usual attendant jump in interest rates.
Do you belong in bonds? If you can stand the volatility, and you feel confident that interest rates are going to remain under control, there’s no reason to budge. If you’ve been in bonds for some time, you have to put the first-quarter’s losses into perspective: The same typical Treasury bond fund that lost 1.95% in the first quarter gained 14.5% last year.
But those investors who really aren’t investors at all--the conservative savers who need to know that their $1,000 or $10,000 or $100,000 principal will be intact at every moment--may want to think about going back to CDs.
The first quarter was just a taste of how nasty the bond market can get at times. If a 2% investment loss isn’t something you can brush off, you don’t belong in bonds. A CD yield of 4% may not be much, but it’s safe, and it’s more than adequate if it also means you can sleep at night.
Rates: Down Again Interest rates jumped sharply in the first quarter on expectations of strong economic growth, but now those expectations are fading. 5-year Treasury note yield (weekly closes, expect latest) January: 5.98% March: 7.08% April: 6.69% Source: Federal Reserve Bank of St. Louis
How Bond Funds Fared
Here are average total returns--interest earned plus or minus bond price change--for key categories of bond mutual funds in the first quarter, last 12 months and last five years. Also shown is how the average stock fund performed in those periods.
Total return: Fund category Qtr. 12 mos. 5 yrs. Junk corporate bonds +8.01% +28.9% +39.2% Money market funds +0.94% +5.0% +40.3% Adjustable-rate mortgage bonds +0.89% +7.6% NA Calif. municipal bonds, long term +0.25% +9.6% +37.7% Mixed bonds +0.16% +13.9% +46.5% General municipal bonds, long term +0.12% +9.8% +40.6% High-quality corporate bonds, 1- to 5-year +0.04% +9.4% +45.2% U.S. govt. bonds, 1- to 5-year -0.58% +8.8% +44.6% Lower-quality corporate bonds, long term -1.02% +12.1% +48.9% High-quality corporate bonds, 5- to 10-year -1.18% +10.9% +47.6% GNMA bonds -1.34% +10.5% +52.5% High-quality corporate bonds, long term -1.52% +11.6% +48.1% U.S. govt. bonds, 5- to 10-year -1.56% +10.0% +44.5% U.S. govt. bonds, long term -1.95% +10.1% +44.6% World bonds -2.41% +11.0% +56.8% Average stock fund -0.17% +15.0% +54.2%
NA: Not available (funds are too new)
Source: Lipper Analytical Services Inc.
