Friday, January 15, 2016

Bonds Won’t Protect You If Stocks Crash.......

Bonds Won't Protect You If Stocks Crash

With yields so low, government bonds themselves pose a huge risk

Treasury bonds proved reasonably cheap in 2008. Ten-year Treasurys sported yields of 4% at the start of 2008 and even one-year Treasurys were paying 3.3%. Bonds move like seesaws: When the yield goes up, the price goes down, and vice versa.

The financial crisis in 2008 plunged the world into deflation, or falling prices, and fear of depression. In those circumstances, Treasury bond prices 
rose sharply and yields fell. Vanguard's long-term bond fund, for example, rose 20% in price in 2008.

The most common investment advice is to hold a "balanced" portfolio of stocks and bonds, so that when their stock portfolios take a tumble, their bonds will provide some offsetting gains. Someone with 60% of their money in stocks and 40% in bonds may have experienced only minor losses overall in 2008.

This time around, though, Treasury bonds have a much harder job pushing the cart up the hill. They've already started the year with the kinds of yields we saw at the end of 2008. For instance, the 10-year Treasury bond today pays just 2.17% — almost identical to the 2.13% in December 2008, when everyone was panicking.

And that's an ominous problem for investors. 

To provide 2008-style levels of protection, Treasury yields, in effect, will have to halve again — to as little as 1.5% interest on the 30-year bond. Such an event would be extraordinary. It will happen only if investors worldwide embrace the idea of persistent deflation, or falling prices.

If stocks have a terrible year and Treasury bonds don't step up, an investor with a balanced portfolio may end up losing even more money than in 2008. 

And if inflation fears were to pick up, bonds could actually fall as well. Investors, cushioned by a gigantic 30-year bull market in stocks and bonds, have forgotten that, in very bad situations, both stocks and bonds can crash at the same time.

It happened in the 1940s and in the 1970s. And if investors are honest, they have to accept the risk that it could happen again.

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