Why Are You Buying a Stinkin' Bond Fund Now?
Interest-Rates / US Bonds Aug 25, 2010 - 08:15 AM GMTBy: DailyWealth
Dr. Steve Sjuggerud writes: You're guilty... You're busted.
But it's not just you... Everybody is doing it. Everybody is buying bond funds.
As I'll show you, this is incredibly foolish.
First off, I know what you've done... I know 98% of the money that's flowed into the Franklin Templeton funds this year has gone into bond funds. The trend goes back farther...
For the last 30 months in a row, inflows into bond mutual funds have topped inflows into stock mutual funds. And the totals are just ridiculous... $559 billion has flowed INTO bond mutual funds in the last 30 months, compared to a $233 billion OUTFLOW from stock funds.
So you've sold your stocks and you've bought bond funds. But why?
Look, as I write, 10-year government bonds pay 2.48% interest. Meanwhile, the average bond fund charges 0.61% in annual fees. Think about that...
Right off the top, you're giving up 25% of the interest you'll earn to the bond fund manager. Why would you do that? Next, think about this: The BEST you can earn in interest in that bond fund is less than 2%. But the WORST case is really bad...
If interest rates happen to rise from 2.5% to 3.5% over the next 12 months, your principal (the amount you invested) will crash in value. A $10,000 investment would fall to $9,200. If interest rates rose to 5%, your principal value would crash to $8,200. Those numbers don't include any fees... That's just basic bond math.
If you held an individual bond, you could hold until maturity, and you'd be OK... you'd get your $10,000 back. But not in a bond fund... The bond fund manager may well sell losers at a loss, year after year. If interest rates go up year after year, bond fund losses will keep increasing year after year.
Do you really want to lend money to the government and earn less than 2% interest? Do you really want to have the risk of your principal (your initial investment) getting eaten away from both fees and potentially higher interest rates?
The miniscule interest is not worth the horrible risks.
Consider the early 1980s versus today: In the 1980s, when interest rates were in the high teens, nobody wanted government bonds. They were considered "certificates of confiscation." Investors were fearful. They weren't willing to accept 15% interest rates from the government, because the national debt was fast approaching $1 billion, which was one-third of GDP.
Today, with interest rates of 2.5%, investors are flocking to bond funds. Meanwhile, the national debt will hit $15 trillion and reach 100% of GDP next year.
Go figure.
Investors are scared of stocks... They haven't made any money in stocks in over a decade. Meanwhile, stocks are the cheapest they've been since the late 1980s.
You want to buy what's cheap and sell what's dear. That's how you make money investing.
Stocks are cheap. Meanwhile, bonds are dear. So what are you doing buying bond funds?
Good investing,
Steve
Editor's note: If you're looking for low-risk ways to increase your income in retirement, Steve has put together a full report on how to up your Social Security payout by as much as $1,068 per month – and how to take advantage of several other little-known Social Security "loopholes." To learn more, click here for a video presentation.
The DailyWealth Investment Philosophy: In a nutshell, my investment philosophy is this: Buy things of extraordinary value at a time when nobody else wants them. Then sell when people are willing to pay any price. You see, at DailyWealth, we believe most investors take way too much risk. Our mission is to show you how to avoid risky investments, and how to avoid what the average investor is doing. I believe that you can make a lot of money – and do it safely – by simply doing the opposite of what is most popular.
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