Bonds have been traditionally considered a safe bet for cautious investors.
But that may no longer be true.
That’s because, according to many experts, we may be in the midst of a ‘bond bubble.’
And like all bubbles, this one may burst.
After the stock market crash in 2008 heralded the Great Recession, many investors began looking for a safer alternative.
The search for security was particularly strong among older Americans. With less time to recoup losses and with limits on their ability to generate additional income, seniors needed predictability and security. Bonds—with guaranteed, albeit lower expected returns, were a natural fit.
Such steady demand, though, continually drove bond prices upwards. The value of bonds soared and encouraged even more people to purchase the asset. A bubble formed.
But this is a historically unprecedented period because interest rates have never been this low in recorded history.
And it’s a global phenomenon too: in Japan and Germany, interest rates for large corporations are now negative! Companies are actually being paid to borrow money.
This type of negative interest rate is completely new to economists. As a result, there is a great deal of uncertainty. No one knows what is in store for the world economy.
Many fear that if inflation were to return to historically normal levels, interest rates would skyrocket.
And therein lies the possibility for the proverbial pop.
Because if rates rise, the value of older bonds will plummet.
Here’s the expected scenario:
In 2016, Ann purchased a $10,000 government-issued bond with a 20-year maturity and a 2% return.
By 2018, interest rates have risen to 4% per year. If Ann wants to sell her bond prior to maturity, she will not be able to recoup her $10,000.
Instead, Ann’s investment is now worth less than $7,500. She would have been far better off earning zero interest for those two years, and then taking her $10,000 and investing it in a new 4% bond.
Millions of Americans—most of whom are older—are positioned to suffer the same kind of loss.
Their only hope is if their bond was invested in TIPS, which are Treasury Inflation-Protection Securities. Those type of bonds rise or fall based on inflation, rather than on a locked-in interest rate.
Bonds with shorter maturities also will not suffer the same fate as investors will not be trapped for as long a period. They can purchase new bonds at the higher interest rates much sooner, limiting their loss and cashing in on a future higher return.
If you are invested in the bond market, it is important to review your portfolio to prepare for any negative outcome.
At Silverman Financial, we can help you examine any potential risk you may be facing. We can suggest solutions to offset possible losses and protect your financial future.