Cash in Hand
The Risk in Buying Bonds Now
By Jeffrey R. Kosnett, Senior Editor, Kiplinger's Personal Finance
August 5, 2002
If you’re part of the stampede into Treasury bonds or funds, remember that just because bonds aren’t stocks doesn’t mean that they are risk-free investments. In fact, while the downward trajectory of the stock market is dragging stocks into more reasonably priced territory, bonds are expensive.
Today’s yield on a ten-year Treasury bond is 4.3%. At a time when good companies’ shares drop by that percentage in an hour, that yield sounds reassuring. But this low yield is the result of months of relentless buying of Treasuries and other bonds, mostly by people looking for a refuge. (Remember that yields fall as prices rise, as they do when investors are buying rather than selling bonds).
Tumbling Treasuries?
Just as stocks can have an overextended bull market, so can bonds. Once sentiment turns -- and it will because the economy is okay, and profits are decent and bound to improve later this year -- Treasury bonds will tumble in market value, and by more than you think.
Just how far? The value of a bond moves inversely with the direction of interest rates. When yields are stretched, these values are more elastic. If today’s 4.3% yields move to 5%, that’s a 9% loss of the bond’s value. A run-up from 4.3% to 6.25%, where the ten-year Treasury traded when stocks turned down in March 2000, would be worse, knocking nearly 15% off the bond’s price.
Given the heart-stopping losses in so many stocks, 15% doesn’t seem such a disaster. But is it worth risking a 15% loss when you could buy a much shorter-duration bond or bond fund, yielding maybe 3.5%, which means you give up very little interest? (See “Higher Yields With a Little More Risk.”)
Once the world reaches this same conclusion, the sellers will start unloading bonds, demanding higher interest rates. That won’t necessarily save stocks, but it will be ugly for anyone who figures bonds are rock-solid safe.