Normally, I do not recommend investments one way or the other in this column. But lately I see a trend that deserves attention. That is because it will affect millions of small investors.
Twenty-five or so years ago, millions of folks invested in government bond funds. These were mutual funds that bought and sold bonds from our government. They were the rage because they offered nice income in monthly dividends. And, of course, government bonds were safe. What a sweet combination: income plus safety.
Millions of investors got burned with those funds. They attacked the investment guys who sold them the funds. “My $25,000 has turned to $20,000! How can this be? You told me these were safe government bonds. I had my grandmother invest in these.”
The funds lost ground for a simple reason. Interest rates went up. When interest rates go up, bonds go down. Especially bonds that are not going to mature for many years. I will not go into why this is. Just trust me on this. When interest rates go up, bonds go down.
These days millions of small investors are pouring their money into government bond funds. And municipal (tax-free) bond funds. And corporate bond funds.
They are doing this within their 401k plans and IRAs. (Although tax-free funds are not in retirement plans.) They are doing it with money they had in the bank.
They are doing this for a number of reasons. Some have grown weary of zippo returns in their money markets. Some have chafed over meager returns from bank CDs. Some are testing the waters after retreating from all investments during the near meltdown.
They know bonds are usually safer than stocks. They know the big companies that issue bonds are a fairly good bet. They know governments and their bonds are a really good bet. They are probably right.
But no government can stop the tide from slipping out tonight. And no government can stop bonds from falling when interest rates rise. Tides and seesaws do their thing.
All of which tee up the big question. Will interest rates rise? This prompts another question. Where else can they go? They’ve gone about as low as they can go. So they can’t go down.
If you believe interest rates will stay where they are, fine. If you believe they will go up, not so fine. Not if you are investing in mutual funds that trade in longer-term bonds, that is. When they go up, your bond investments will go down.
And if you believe interest rates will go down - and make your bond investments more valuable – Mr. Madoff will see you now.
From Tom ... as in Morgan.
For more columns and for Tom’s radio shows (and to write to Tom): tomasinmorgan.com.