If you have money in bond funds, sell them while you still can. If you own bond funds, find alternative places to put the money (such as dividend-paying stocks) before the inevitable sell-off occurs.
This article is published with permission from InvestmentU.com and is slightly edited from the original version as it appears on InvestmentU.com
Last year, my wife and I decided to buy an investment property. One talent I do not have is to be able to walk into a home and see the potential. If it doesn’t already look great, then I’m not interested.
Fortunately, my wife is much more practical. So I let her find our new property and I handled the financing, something she despises. She uncovered a great condo and I rode the mortgage broker hard
like a rodeo champ.
The mortgage rate on the property was an important factor to whether the deal made sense. Rates had come off their historic lows, but were still very cheap.
As the deal matured, I watched every tick of the 10-year Treasury note. (Most mortgages are based on this key rate.) Finally, when we had a move to the downside, I called the mortgage broker and told him to lock it in.
“We have time,” he said. “There’s no rush.”
“Lock it in now,” I shot back.
He tried to talk me out of it, saying that if the property didn’t close when we expected it to, we’d have to pay to keep the rate. I told him we’d get the closing done and I wanted that 3.25% 30-year fixed rate locked in.
He locked it in… And rates went higher shortly after.
Back then, the 10-year note was trading at about 1.67%. Today, it’s back above 2%, and I suspect it to stay above that key threshold.
Unless you’re in the market for a mortgage, you probably don’t care about rates — but you should.
Many folks will see their retirement funds get slammed as a result of rising rates.
Remarkably, investors are still pouring money into bond funds. Stock fund inflows get the most media attention, as investors are once again putting money into stock funds rather than taking it out, reversing a multi-year trend.
But money is still rushing into bond funds.
In fact, municipal bond funds have seen seven straight weeks of inflows
with $780 million flowing into the sector over the last two weeks. High-yield funds added $148 million in new money in the past two weeks. And investment-grade corporate bond funds saw a whopping $1.6 billion come into their coffers.
In all of 2012, an astounding $227 billion flowed into bond funds.
It’s sad to say, but investors would be better off heading to the roulette wheel and putting that money on black. They’re more likely to emerge with all of their money than if they buy bonds.
As Investment U's Steve McDonald has said numerous times… Bond funds are deadly.
Yes, the Fed has pledged to keep short-term rates at zero. But the Fed doesn’t control the market. (Sorry, Ben.) If investors
especially institutions and foreign governments
stop buying our debt, rates will soar.
It’s the simple law of supply and demand.
Currently, the 10-year is at 2.05%. Three months ago it was at 1.65%.
What happens if China or Japan decides a return of 2.05% isn’t worth the risk of holding a U.S. Treasury for 10 years?
What if they don’t trust our do-nothing Congress to straighten out our exploding debt situation, and these key lenders decide they need 2.5%, or 3% or 5% for the risk of holding a U.S. debt obligation?
Sadly a lot would happen. But most notable for our discussion is that the quarter of a trillion dollars invested last year (and billions more from 2011, 2010) in bond funds would suffer huge losses.
Think of it this way. If you paid $100 today for a bond that paid 2%, what would you pay tomorrow if a new bond with a 3% yield goes for the same $100?
You’d pay a lot less for that 2% bond.
As rates go up, bond prices fall. And there are a lot of pension funds, sovereign funds and mutual funds that are stuffed to the gills with bonds, in danger of losing big money if prices fall.
What to do about it
If you have money in bond funds, sell them while you still can. They will lose value over the coming years.
Put that money into stocks with a history of raising their dividends. By investing in stocks that raise their payouts annually, you ensure you will get a pay raise every year.
Even in the best of times, that’s a feat no bond fund can offer.
A stock like Exxon Mobil (NYSE: XOM), on the other hand, that raises the dividend 9% to 10% per year, means you’ll make 9% to 10% more money every year from your income investments.
And, as you should know, stocks with track records of annual dividend raises tend to be safer investments than other stocks. In fact, companies with track records of raising the dividend for 25 years or more have never lost money over any 10-year period going back over 32 years of rolling 10-year periods (i.e. 1981-1991, 1982-1992, 2002-2012)
Even if you’re not in the market for a mortgage, keep a close eye on the 10-year bond yield. As it ticks higher, you’re going to hear more and more about the devastating losses suffered by large institutions and sovereign funds.
And as those losses mount, bonds will be dumped, making the carnage even worse.
If you own bond funds, find alternative places to put the money before the sell-off occurs. Otherwise you’ll be selling in the panic with everyone else.
They say it’s better to be lucky than good. Fortunately, when it came to my mortgage, I was both. I got lucky that rates dipped, and I was smart that I locked it in.
You have the same opportunity now with bond funds. The steep losses haven’t started yet, so take advantage of your good timing and get out unscathed while you can.
Note: These rate hikes, coming much sooner than most expect, will crush individual investors who are not prepared. And it’s likely to happen in a matter of minutes. But those who understand this situation will not only survive disaster, but stand to soak up significant wealth.
Marc thinks clued-in investors are looking at as much as a 164% windfall, plus thousands of extra dollars each month when this three-minute event occurs.
And he’s so convinced that he’s spent more than $100,000, and 17 months, preparing a brand new presentation. It reveals how three breathtaking minutes could mean the difference between retiring rich… or retiring broke.
For complete details, please click here for Marc’s in-depth research. Marc Lichtenfeld is a senior analyst at Investment U. See more articles by Marc here.