At the end of the 1970s inflationary bout, in 1981 the 10-year Treasury note hit a historical high of 15.84%. In a crisis-driven rush to safety, on Aug. 8, 2012, the rate hit an all time low of 1.394%. When interest rates decline, the value of a bond rises. Think about that.
Over more than 30 years interest rates trended down and bonds as an asset class benefited. Many financial advisers and investors experienced only a bull market in bonds, never a prolonged bear market. Since bond values drop as interest rates rise, complacency and recent experience can be dangerous.
For 11 days since Jan. 30, the 10-year Treasury closed at or above 2%. And until it slipped slightly below that level Thursday, the yield on the 10-year note topped 2% for eight straight days.
The trend is to the upside. Losses are reflected in bond mutual funds, exchange-traded funds and other fixed-income holdings. The bond game has not halted. But the 30-year bull market in bonds is dead, and the game is changing.
With any fixed-income holding, given falling interest rates in recent periods, don't look at past performance as a guide in fund selection, especially in 401(k) and other retirement accounts. When interest rates rise, aggravated by inflation, fixed-income investing is not likely to grow future buying power on a net basis, after taxes and inflation.
At that point, meet with your financial adviser. Rethink your investment policy. Bonds as a defensive mechanism may require a change in strategy. What performed well over the past several years may not keep doing so.
As Lombardi would say, a review of fundamentals is wise. How exposed are you to losses because of potentially rising interest rates? What is your money for? How long will it last given forecasted expenses, tax rates, inflation and your expected longevity?
What is your tolerance for risk (aka volatility)? Are you saving money or spending down your stash? Should alternative asset classes or defensive strategies be included in your asset allocation, as many large pension funds are doing?
Heed the 2% warning. It's a game changer.
-- By Lewis J. Walker, president of Walker Capital Management Corp. and Walker Capital Advisory Services.
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