With the stock market bouncing like a flea on a hot plate, investors are looking for a safe haven.
For many, that safe haven has been the bond market with U.S. Treasuries and blue chip corporate bonds the ports of choice.
The so-called “flight to safety” has seen billions of dollars pulled out of the stock market and dumped into the bond market over the past 18 months.
For some investors, the “flight to safety” may end in disaster. Here’s why:
Interest rates are at historic lows, so bonds are not paying much – the safer the bond, the less interest it pays.
For those investors planning to hold the bonds to maturity, this is not a big problem.
Many of these folks are in or nearing retirement and their main concern is preservation of capital. They want to know when the bond matures that they will get their money back.
Other investors that have flown the stock market for bonds may have put themselves in a tough and risky position.
Interest rates will rise, perhaps sooner than many think.
When that happens, older bonds with low stated interest rates will not do well if an investor tries to sell them before maturity.
When interest rates rise, bond investors may want to get back into the stock market or simply get out of the bond market.
The older bonds will not sell at face value in the open market. Bond holders will have to discount the face value to sell older bonds.
There is no magic answer for investors.
If you are near or in retirement, your first priority is capital preservation (don’t lose money). Secure bonds are a good choice.
However, if you plan to move back into the stock market, holding low-interest bonds in the face of rising interest rates is a losing position.
Not only will you take a loss on the bonds, but you will likely be buying into a rising stock market, which is not the best position.
Your best strategy is a balance portfolio of stocks and bonds that reflects your risk tolerance and investing priorities. Trying to guess which way the markets and interest rates are headed is dangerous.
