Spotting the Bond Bubbles

HUNT VALLEY, Md. ( TheStreet) -- Two common beliefs for those approaching retirement are: the closer you get to retirement, the more bonds you should own; and that when you are retired, bonds should be a mainstay of your portfolio to generate income. These beliefs were created by the misperception of income and safety.

Income is typically defined as "interest and dividends," but income can come in any form of distribution used to live on without affecting the original principal balance. With this interpretation we can include capital appreciation. In other words -- total return. Some would say interest and dividends are safe income, but capital appreciation is not. In some regards this is true, but we must realize, especially now, that interest and dividends are not absolutely safe either. Dividends have been slashed in the past five years, especially in financial securities. Interest rates are so low that only the wealthiest could survive on the cash flow. Total return is now, and has always been, the only proper way to focus on income for a retirement portfolio.
U.S. Treasury Bonds are considered by some to be the biggest asset bubble since the subprime mortgage fallout of 2008.

Safety is another story. Most people define safety as "low volatility." Bonds have been less volatile than stocks over the past 100 years and are, therefore, proclaimed "safer." Volatility is the measure of the rise and fall of principal value over a set group of time horizons with the most common being yearly. If the annualized return of a stock went from +30% on the high and -35% on the low and a bond went from +15% to -12%, bonds would be safer than stocks. This is a logical assessment of how one would view an account on an annual basis, but it has nothing to do with risk. Risk is about the price I pay for the asset I get. As the price of an asset drops, the value of the asset becomes less risky; when the price rises, the asset gets riskier.

So, looking at today's environment, where is risk highest and lowest?

U.S. Treasury Bonds are beyond any doubt the biggest asset bubble since the subprime mortgage fallout of 2008. It's a bubble that will not come with wholesale bankruptcies like in 2008, but it sure could hurt the typical, unknowing investor that is using a volatility-based risk assessment. Asian stocks are probably the least risky asset class in the world, since the price of those securities is still down a bit from their highs and the long-term growth potential is stellar.

Today, U.S. and European stocks are getting the limelight, but they cannot go anywhere without the Asian economies. Why? Because the Asians are the manufacturers and creditor nations, making them the engine of growth of the middle class. Their markets are not doing as well because they are trying to control the inflation being exported from money growth abroad.

The U.S. and European markets are not bad, risky investments based on a price basis. It's just that the Asian economies and markets are a far better long-term risk reward proposition.

I have learned two things about investing in my career as a comprehensive, fee-Only financial planner. First, never invest in a greed- or fear-based market (1999 was a greed-based market, thanks to the dotcoms). Second, never invest in a manipulated market other than for a short period (silver was a market manipulated by the Hunt brothers in 1979). Today, the U.S. Treasury Bond market is saturated in fear from investors who lost tremendous amounts over the past four years, and it's a market heavily manipulated by the Federal Reserve. No matter why investors are fearful or who is manipulating the bond market ... buyer beware.

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Andrew Tignanelli, CFP, CPA, is president of Financial Consulate, based in Hunt Valley, Md., and a member of NAPFA, the National Association of Personal Financial Advisors.

This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.