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In this week’s Mullooly Asset Management podcast Tom and Brendan answer the question, “Why are bonds risky?”. Tom begins by pointing out that Alan Greenspan, Ben Bernanke, and Warren Buffet have all cautioned against bonds recently. Bernanke said (of bonds), “They are among the most dangerous of assets”, as quoted from this post from Forbes. So why is this the case? Why are bonds risky in 2013?
Tom explains that for the last thirty years interest rates have gone in one direction only. That direction has been down. This has meant that the value of bonds has stayed up and actually gone up because of the dropping interest rates. Tom reminds investors that the average rate for long term bonds is just over 6%. Currently in 2013, long term treasury bonds yield just over 3%. This is significantly under where the long term interest rates are normally found.
In 2013, the roles of bonds and stocks have been reversed. Tom makes this point by explaining that bonds have been safer for the last thirty years, but have become risky. Investing when interest rates are low is not something many investment advisors would recommend. There’s a lot of potential for loss when rates are low. This helps to explain the question, “Why are bonds are risky in 2013?”. Conversely, stocks have become a little bit safer. Tom means this in the sense that they have become a good alternative for people looking for income from bonds. Investors can find plenty of well known stocks to buy today, and they would collect a dividend higher than the thirty year treasury bond.
Tom and Brendan also discuss the relationship between bond yields and bond values. Tom explains that they have a direct, inverse relationship. When the bond yields go up, the bond value will go down immediately. Tom also wants to assure investors that if you plan on holding bonds to maturity, and you didn’t pay a big premium, you will be OK.
So why are bonds risky? Hopefully after reading this and listening to this week’s Mullooly Asset Management podcast you can correctly answer that question!