Hi there! Today I am having Pat Murphy, the publisher of Feeling Financial. talk about how to keep your investments safe. Pat writes about personal finance with a focus on how our emotions and behavior affect financial outcomes. Let me know if you would like to submit a guest post.
Over at Make Money Your Way, Eva from TeensGotCents is talking about how to make money in college and graduate debt free, see you!
It’s hard to have a conservative mix of investments these days. With
the threat of rising interest rates, even “safe” investments are
starting to look scary.
Over the past few months, I lost some money in an account that I use
for somewhat “safe” money. This is money I may or may not need over
the next few years, so I invested about 70% in bond funds and 30% in
stock funds. I don’t want to lose it all in a stock market crash, but
I’d like it to earn more than I can get at the bank. The account is
still positive over the time period that I’ve used it, but I’m
disappointed about seeing losses.
I suspect that a lot of people are in the same boat: anybody who
depends on bonds for stability might be in for a bumpy ride.
Bonds Losing Money
Bonds are traditionally considered safe, but you wouldn’t know that by
looking at your last quarterly statement. Of course, any investment
can lose money, but aren’t bonds supposed to stabilize a portfolio?
The fact that bonds can lose money is news to a lot of people. The bad
news is that this is probably just the beginning: as interest rates
rise, traditional bond investments are likely to lose money. Interest
rates are extremely low right now, so there’s really nowhere to go
except up. Granted, we’ve all seen this coming for a while, but things
got messy in May when the Fed announced that they might (someday)
allow rates to drift higher.
What’s an Investor to Do?
If these bond losses are a result of rising interest rates, what can
we do? Lighten up on the types of bonds that lose money when rates
head north. In general, safer bonds with a long “duration” tend
to lose value as rates rise.
Now, I should mention that I don’t believe in timing the markets – I’m
certainly not smart enough to pull it off. Who knows if rates will
rise anytime soon? If they did rise, who knows how fast it would
happen, and how much bonds would actually suffer? That said, I think
it’s a decent idea to shift some “safe-ish” money into bonds that are
less likely to get beat up as rates rise (my medium-term money, for
example – I’m not doing much if anything to retirement accounts).
Making a huge change or trying to sidestep a market crash by going to
cash and then jumping back in is not something I’m interested in.
There are a few types of bonds (or bond mutual funds, for us regular
folks) that seem to hold up better as rates rise:
Short-term bonds don’t suffer as much as long-term
bonds because you’ll get your money back more quickly with a
short-term investment. Then, you – or the fund – can reinvest into
newer, higher-paying bonds. However, short term-bonds generally don’t
pay as much as long-term bonds (assuming all else is equal). So you’ll
earn less income from those investments, but the hope is that that
your account value won’t drop as much if rates rise quickly.
Floating-rate bonds have time frames that are even
shorter than short-term bonds. These might consist of variable rate
loans that banks make to companies. As interest rates rise, the
interest rate on the bank loan will change correspondingly, and the
increased income is passed on to investors. Floating-rate bonds
usually have a higher yield than short-term bonds, but they are also
riskier investments.
High-yield bonds, also known as “junk bonds,” pay
high rates of interest because they are high-risk loans. These aren’t
necessarily short-term bonds, but they can be insulated from rising
rates in a different way: as the bond issuers get stronger (by
improving profits in an improving economy, let’s say), their bonds get
more attractive and rise in price. This price increase can help offset
what would otherwise be a price decrease due to rising rates.
What’s the Catch?
Of course, you can never get something without giving up something
else. So what are the trade-offs of shifting to shorter term bonds and
higher risk bonds?
First, rates might not rise, or they might not rise quickly enough to
cause problems. In that case, moving to short-term bonds that pay less
means leaving money on the table. Also, floating-rate bonds and
high-yield bonds are riskier (not so much due to interest rate risk,
but because the bond issuers might run into financial trouble and quit
paying bondholders). As a result, these types of investments are more
volatile and can move up and down – most importantly down – similar to
the stock market. If the economic recovery loses steam, safer bonds
might be the place to be.
Finally, there are other types of investments out there. It’s not just
stocks, bonds, and cash. “Alternative” investments could also be
helpful as rates rise (and, correspondingly, as the Fed tries to hold
off inflation). The challenge is how much of each
investment to use. It seems like you have to have at least
something in bonds to keep a balanced portfolio.
My Plan
Given all of that, I’m just going to make modest shifts in the bond
portion of my account – not dump everything into short-term and
high-yield. Keeping some exposure to plain-vanilla bonds allows the
account to earn interest and stay stable in case rates don’t
rise; beefing up the short-term and high-yield portions should help
the account weather the storm in case rates do rise.
How do you keep your “safe” investments safe?
You can find Pat over at Feeling Financial or on Facebook.
This post was featured on the Money Life and More, Debt Roundup, Mom and Dad Money, Blog Post Directory, The Swanky Carnival of Retirement, Feeling Financial, thank you!
I cant say I have any safe investments at this point. Other than what we have in the savings account that by my calculations is losing money are we are not even keeping up with inflation. When I look at the end of the month and see several cents deposited Im just in shock. But hey better then seeing $1k loss I guess. I haven’t invested in any type of bonds at this point. May I will later on down the road but didn’t see a need to have those. Diversifying is the key so those make be my next choice for adding to my portfolio.
Yes, it’s frustrating to see how little you get from a savings account. I guess that’s why people accuse the Fed of pushing people into riskier investments.
Have you looked at dividend aristocrat stocks? These are stocks that have increased their dividends for at least 25 years straight. I think that’s safer than bonds, especially the next five years or so…
There’s no such thing as a “safe” stock, at least in terms of being confident that a certain amount of money will be available to you within the next few years. Dividend aristocrats are no different than any other stock in being susceptible to huge drops in value over short periods of time.
Thanks for the suggestion, I’m not familiar with them. For now I think I have enough exposure to stocks in that account. In my mind stocks just put me in a different risk category than bonds (they might not be much riskier than high-yield but I think of them as having a different character somehow). Always good to learn about different strategies though.
I’ve stayed away from bonds altogether lately, but I’m hearing chatter that some of the big boys are starting to get back in even as rates are rising. I am largely in stocks – from a few good dividend payers to some growth stocks. If I were to get into bonds right now, I would avoid anything that is long term in nature. Bonds are, in some occasions, riskier than some stocks – much why you need to stay on top of what’s going on in the market and your portfolio.
That all makes sense, I’m just not good at staying on top of things. I’m too lazy to check in on my accounts any more than once every few months.
Honestly I don’t invest specifically in bonds so I don’t have much to say about them. I have a 401k and have a few mutual funds, though, and I try to keep a good mix of the types of funds I own (emerging market, target retirement date funds, etc.).
That’s the easy way to do it, and a smart way to go. My 401k and IRAs are target date funds with a few flavors sprinkled in as well. Keeps life easy and I figure they can do a better job than me. Even in this “medium-term” account, the stock portion is a target date fund — there are just a few extra bond funds in there for diversification.
The problem happens when people are frustrated with low interest rates and so they start moving the “safe” money towards higher-yielding investments. The fact that you’re frustrated with low rates is NOT a reason to chase higher rates in riskier investments. If you want to chase higher returns, you have to be okay with losses. There’s just no way around that. We have to deal with the world we’re given, not the world we want, and the world we’re currently given provides meager returns if you want to keep your principal in tact. That’s just the way it is and there really isn’t a way around it.
It’s certainly tempting to “do something” drastic, which is like climbing out on a limb just a teeny bit farther… Your point is a good one that the account has been doing exactly what it was supposed to do for the past few years, and it’s still doing that (even though I don’t like it as much right now). I am guilty of moving the goal posts a little bit, but I hope — I want to tell myself at least — I’m being somewhat reasonable by keeping my changes modest. I should mention for anybody who might be interested in safety that this account is only partly “safe” but it’s nowhere near as safe as a bank account and I’m willing and able to take risks with this money (I think of it as a backup to emergency savings, and a safety net if my income drops). Any shift to high-yield and floating-rate certainly increases risk.
In a well-diversified portfolio, I guess it’s a good sign if something is losing money at any given time.
Thanks for the intellectual content. I’m staying away from bonds, since I have time to recoup losses. When your young, you can take high risks to get those high rewards.
Thanks for saying it’s intellectual! Being young is nice: your knees and back don’t hurt, and you get to be a very-long-term investor.
I try to keep a good mix, but most of my investments are long term at this point and mostly stocks. I think rebalancing annually and not getting carried away by talk and market swings is very important. I know people who pulled out of stocks for bonds after 2008 who took a big loss and will likely do so again when rates rise. Emotion has no place in investing
That’s so true. Keep the TV turned off and don’t get sucked into the hype.
Thanks for the theory on bonds. I shy away from them based on my personal preferences, so I haven’t learned a great deal about them.
The only “safe” investments we have are CDs. We have some savings account but don’t keep much. The CDs are international CDs but they stay in dollar so no forex transactions. Having a CD in another country is still risky but as I grew up in that country I know the banks well and feel safe. Other than that we are pretty aggressive, we still have 90% in stocks in our retirement portfolio. Probably time to rebalance.
Wow, I’d love to learn more about how the international CDs work. Not sure if I’d ever really do anything but I’m curious.
Bonds can be consider a low risk investment but I think it’s really best for you to shift some of the money you invested on bonds to other investments. But I really think that you just put it on a high yield savings account, that’s the safest bet for you. 🙂
Pat! Loved your article. “my medium-term money, for
example – I’m not doing much if anything to retirement accounts” Does this mean that mean only for your safe-ish accounts or overall? And, can you point me in the direction of a few of these alternative investments or perhaps give an example? Or shall I simply visit your site? Have a Jolly one, Pat!
Thanks CJ. Yes I’m only changing the safe-ish account. For retirement accounts I’ll just let whatever happens happen over the next few years. If the bonds in there lose money I guess I’ll just buy them at a lower price.
For alternatives I just use a “multialternative” mutual fund to keep it simple. I’m hesitant to suggest any specific one, because I don’t know if I’m smart enough to tell anybody else which particular one is any good. Depending where you have accounts hopefully there’s a good option available. Some people pick individual alternatives and decide how much to put in each but that’s not really my thing.
Thanks for your reply, Pat, and for clarifying. Much appreciated!
If you keep a bond until it matures, you are going to get par value for it, regardless what rates do in the interim. Yes, if you sell before maturity, you will get less than face value for the bond, but if you hold to maturity, you will always get face value.
I would not use high-yield bonds for my safe investments. high-yield bonds carry about the same risk as stocks. I personally use CDs for my current safe harbor. I will move back to bonds when their yields are once again substantially better than CDs.
Thanks for writing this review! I’ve been intending to start investing with Betterment.