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Income Investors… Here’s The Biggest Mistake You Can Make
by Alexander Green, Chief Investment Strategist
Monday, February 1, 2010: Issue #1187
According to Crane Data of Westborough, Massachusetts, the 100 biggest money market funds are currently paying an average of .05 percent.
This is the smallest return that money markets have ever paid. To put it in perspective, at the present rate, it would take more than a 1,000 years to double your money.
I’ll go out on a limb here and suggest that may be a tad longer than your personal investment horizon.
Here’s what not to do in response to this…
Chasing Higher Returns… In the Wrong Place
Investors who panicked during the market meltdown a year ago and have hidden in cash investments for 12 months are really suffering. Not only did they get stung in the market’s selloff, they’ve earned next to nothing in cash and have missed an enormous rally in corporate bonds and stocks.
If you go back in history and look not just in the United States, but also in global fixed-income markets, the gap between long and short-term rates has rarely been greater. Translated into the parlance of the bond market, the “yield curve” has seldom been steeper.
So in order to escape today’s microscopic yields, mutual fund money-flow reports show that many income investors are shoveling money out of their money market funds and into long-term U.S. government bonds – and the funds that invest in them – because they’re higher yielding and “safe.”
Uh-oh…
When Interest Rates Rise, Bond Investors Will Pay the Price
What many of these investors don’t understand is how badly they can – and almost certainly will – get whacked when interest rates start to rise.
The Federal Reserve and other central banks around the world have maintained an extremely loose monetary policy in order to restore the health of the global financial system. And while we’re still only in the fourth or fifth inning, things are definitely looking up.
(Those who want to debate this point can argue with the world’s financial markets, not me.)
Eventually, Federal Reserve Chairman Ben Bernanke (who just got reappointed to a second four-term in office) will start taking short-term rates higher. That will probably happen in the second half of this year. Longer-term rates will rise, too. In fact, they’ve been on an upward trajectory since late November.
Yield-hungry investors – the same ones who over-invested in stocks two years ago when they thought the coast was clear – are now plowing into Treasuries at precisely the wrong time.
How can we be sure?
- Because when bond yields rise, prices fall. The effect is magnified for longer-term securities, so a 30-year bond will fall in value much more sharply than, say, a six-month Treasury bill.
- Of course, a money market fund will benefit as interest rates rise. But even if the Fed lifts rates by 100 basis points – a full percentage point in layman’s terms – the yield on a money market will still be only 1%.
It’s tough to imagine reaching your investment goals at that rate. However, investors in Treasuries face an even bigger problem…
America Is About to Lose Its Triple-A Membership
Because of long-term structural deficits in the United States, Treasuries may soon see a ratings downgrade.
Everyday investors will see this as a stunning bolt out of the blue. But they shouldn’t. The writing has been on the wall for a long time.
Congress has spent the past three decades spending money like sailors with four hours of shore leave. Eventually, the piper must be paid. And it will come in the form of our sovereign debt losing its vaunted Triple-A credit rating.
Want someone to blame? Contact your Congressman and your two Senators. Tell them you know what they’ve been up to lately: http://www.usdebtclock.org/
In short, there are plenty of great places to invest for yield right now. I can assure you that long-term Treasuries are not one of them. On the other hand, the Oxford Club’s Perpetual Income Portfolio and Ultimate Retirement Portfolio are full of good ideas – and you can get more details about them here.
Good investing,
Alexander Green
- Money Market Funds: Why Your “Plus” Could Become A Minus
- What to Do When Interest Rates Rise
- Senior Secured Floating Rate Bonds: The Best Investments to Own When Interest Rates Rise
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7 Responses to “Income Investors… Here’s The Biggest Mistake You Can Make”
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Alexander Green is the Investment Director of The Oxford Club. A Wall Street veteran, he has over 20 years experience as a research analyst, investment advisor, financial writer and portfolio manager.
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February 1st, 2010 at 2:55 pm
Where can I find a graph to overlay on my municipal bond fund graph. I want to see how it reacts to interest rate adjustments. Is there a symbol for such a graph?
Reply
February 1st, 2010 at 3:30 pm
Dear Mr. Cooke,
I am already a member of the Oxford Club. Incidentally, many of us would appreciate not getting all the hyped letters and just stick to the Communique and other member communications. Also, I may attend the San Diego conference.
While there is a lot to like about almost all of the Club’s equity and “Gone Fishing” fund portfolios (depending on one’s financial situation and preferences, the Income Fund selections — in my humble opinion — is not one to select without due diligence).
The only security I have selected from there turned out rather well, however the rest of the investments in the Income Portfolio are not my cup of tea. Some of us generally do not like leveraged CEFs and I’m one of them. I do like the Templeton funds — which are not so leveraged, but do make carefully managed currency bets.
I think Alexander Green is a straight shooter. That is ALL important when considering any type of investment advice/service — whether it’s “free” or not. To me, the Oxford Club is a great service and worth the price.
Thanks,
Mike H., Walnut Creek, CA
Reply
February 1st, 2010 at 4:29 pm
With all the interest in gold, you could have commented on how interest rate rise would affect gold prices ,but that would effect your marketing.
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February 1st, 2010 at 7:33 pm
i agree with mike from walnut creek. I am a lifetime member of the oxford club and enjoy many of the emails that I receive, but I too am tired of the hype of other deals on a constant basis and wish you would label them advertisement ahead of time so we could delete them if we are not interested or tell us up front what the deal costs us and what does it pertain to.
bob g. morgan hill
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February 2nd, 2010 at 1:03 am
Have you looked at http://www.usdebtclock.com referred to in your article?
Was expecting a clock with federal debt? wrong
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February 2nd, 2010 at 1:25 am
what you so sure the fed will raise rates? look at Japan
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February 2nd, 2010 at 12:31 pm
I think the saying is “spending money like druken sailors.” However this is a bad analogy, When drunken sailors run out of money, they quit spending!!! Unlike our gov’t!!
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