Should Credit Risk Cause Investors to Sell Treasury Bonds?
The credit risk of treasury bonds has increased as evidenced by the S&P downgrading of United States debt to AA+ from AAA. While I don’t want to down play this historic and tragic downgrade that didn’t need to happen, it doesn’t change the fact the United States is still one of the safest investments on earth. While this will undoubtedly cost taxpayers more money, it is not the real reason to sell bonds.
Interest rate risk, not credit risk, is why you should sell bonds, particularly Treasury Bonds.
Interest Rate Risk of Bonds
The case against purchasing long term bonds is compelling due to interest rate risk. Analysis of the risks versus potential gains might make investors sell long term bonds. Bonds are enjoying a long bull market as interest rates have fallen on 30 year treasury bonds from 14% in 1980 to under 4% in 2011. Since the price of bonds moves in the opposite direction of yields, record low bond yields equates to record high bond prices. If interest rates rise for any reason (i.e. downgrades in credit risk, government deficits, economic recovery, a decrease in foreign purchases of our debt, etc.) bond prices will fall.
Why You Should Sell Bonds
Avoiding a Bond Market Bubble should be on the minds of long term investors. Investors, rushing to safety and higher yields than CDs or money market mutual funds, have created heavy demand for long term treasury bonds. In an effort to bolster the economy and keep interest rates low the Federal Reserve has been reducing supply by purchasing bonds. Heavy demand and reduced supply have raised the price, and therefore lowered the yield to historically low rates. Due to near record prices and low yield, bonds have little potential for appreciation but a large downside risk.
A tactical asset allocation strategy gives investors the flexibility to move out of overpriced assets into undervalued assets. Due to the miracle of compound growth, it is far more important to not lose money in bear markets than to capture the gains in bull markets. Investors who identify bubbles and avoid them greatly increase their portfolio returns and wealth.
In my article, “Sell Bonds and Buy Best Dividend Paying Stocks” I will show you how to replace a bond portfolio with other investments; including dividend paying stocks.
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| AAAMP Blog by Ken Faulkenberry | |
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Ken Faulkenberry earned an MBA from the University of Southern California (USC) Marshall School of Business with an emphasis in investments. Ken has 25 years of investment experience and is dedicated to helping people with self-directed investment management through the Arbor Investment Planner. His asset allocation strategies have an outstanding performance record. |
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I agree completely.Unfortunately the average investor doesn’t understand bond prices and yields. Many will wake up one day and wonder why they ever bought 10 year Treasury notes at 2%. Especially when really good stocks are available at dividend yields that are higher and taxed at a much lower rate!
A similar thing happened in the late ’90s when investors bought stocks at unprecedented p/es just because they were internet related. Some people have to pay the heavy tuition to learn.
Exactly Robert. Unfortunately many people never learn but stop investing because of these mistakes. There are people like you and I that can provide people with the information they need to not let emotions dictate their decisions and successfully invest to meet there goals! Thanks for the note.
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