Quick, what is the best investment today if you want to preserve capital from risk? Bonds? What about tomorrow? Bonds? What about in 10 years? Still bonds? Always bonds? This is lunacy.
Right now your credit risk on bonds (the risk the issuer will go belly up) is tiny. However your interest rate risk (the risk rates will rise, eroding your capital) is huge. Bond prices trade in inverse to their yield. If you wanted to be safe, you could buy a newly issued bond and collect today’s meager coupon on it (the interest rate) and rest assured that in 5, 10, 20, 30 years, when the bond expires, you’ll get your money back, but if you can’t hold to maturity you might not get as much as you hope if rates rise.
Suppose you buy a bond paying 1%, suppose in 5 years bonds of the same time now pay 2%. A reasonable think to happen right? Sure, a 1% rise in rates over 5 years. No big deal, right? Well, if you have to sell that bond, and not hold it until maturity (lets call maturity 10 years), who is going to buy it? No one will buy it at the original price you paid, because they can buy a brand new bond paying double. You need to sell at a price that gives the purchaser a market yield. I hope you can follow along because this is an important point, your bond is now worth 50 cents on the dollar, you have lost half your money in exchange for a 1% yield on a “safe” investment.
And yet, the world over, people tell retirees bonds are safe. This is ludicrous advance.
What about treasuries (US government bonds) they’re safe right? No, this is an example specifically about treasures. Today the 10 year bond pays around 1.8%, in 2000 it paid 6.66%. If you bought a 10 year treasury today and rates only returned to 2000 levels you would lose over 66% of your money.
In 2008 it was about 3.8%, if it returned just to that level you’d lose 50% of your money. If bond prices just RETURN TO HISTORIC AVERAGES you could lose so much of your money. Buying a bond today is like shorting a stock AFTER it has gone down to 95% to $1 a share. Your upside is tiny, your potential downside is catastrophic.
And yet, millions and millions of retirees and soon to be retirees blithely put money in target date funds which idiotically continue to put high allocations into bonds. I read in Forbes that over 40% of all 401k dollars are in target date funds. That is so much money it is starting to move the needle and I think it is a reason why bonds yields are still so low. Trillions of dollars stupidly buying bonds because conventional wisdom is that bonds are always safe (always! Who ever says anything is always safe?!?!). There is, in fact, a bubble in bonds, and it will eventually burst.
What does this mean? 1. If you held a short position like I outlined above, a stock declines 95%, is now just $1 a share, would you continue to sell it short? No, of course not, so why be in bonds? GET OUT OF BONDS. Plenty of investment options are safer than bonds right now, including stocks. Oh yes, the stock market can go down, it did in 2008, and then by 2011 it was back up. The stock market is volatile, but it is safe. Bonds are not volatile, but they’re incredibly dangerous. When yields go up, they won’t go back down after 3 years, they’re likely to never in your life time be this low again, you will not be able to wait it out, you will be screwed.
2. Don’t use target date funds because they are stupid and evil. They’re dumb instruments for dumb investors and they are going to burn people, badly.
3. Be a smart investor and invest contrary to this trend, you will score big when bonds return to historic averages. Currently this trend is predicated by the huge baby boomer population. They’re all in these ridiculous target date funds (that also charge you a management fee for their idiocy), but the generation behind them is smaller. Assuming we’re at “peak target date” the pool of bond buyers will shrink both as the generation size drops, and as baby boomers spend money in retirement. Once a downward trend starts this will accelerate as bond prices fall (yields rising) baby boomers have to sell more and more each month to get their desired monthly income. It creates a procyclical situation (fancy words for death spiral) very similar to the 2008 housing crisis. I can’t tell you when this will happen, but I can tell you it will happen. Bonds will fall, and it will be disastrous for retirees (and possibly college savers, my kid’s 529 plan has target date nonsense too, I avoid it). So you would want to look for inverse bond ETFS. Here is a list, do your research, I own none of this (yet, I think I will buy one, but not sure which). TBF, TMV, TBX, DTYS, do your research and pay attention to expense ratios.
4. What does a world look like where retirees who thought they were secure are suddenly less so? Could they reenter the work force? Would they move away from posh retirement homes to more bare bones ones? Would there be fewer elective lifestyle surgeries? These would be the 2nd stage investing ideas for this trend.