The Risk You Don’t See

© Can Stock Photo Inc. / larryhw

United States Treasury Bonds have long been considered among the safest investments in the world. But bonds with extended maturities, twenty or thirty years, have a lot of risk. This risk seems invisible and under-appreciated in today’s environment.

How would you like a twenty year long term Treasury bond paying 7%? Would that be good for you? People thought so in 1977. But by 1982 when interest rates had risen to almost 15%1, those bonds were only worth fifty cents on the dollar. Worse yet, inflation ramped up and damaged the purchasing power of interest earnings. When rates rise, the value of existing bonds goes down.

Since the financial crisis of 2007-2009, hundreds of billions of dollars have gone into bonds—a record tidal wave of money. One might guess this represents a flight to safety amid the uncertainties of the world. Some people got hurt in real estate, some were hurt by selling stocks after a crash, and they just want to keep their money safe.

Behavioral economics has shown that we humans tend to believe that current conditions and current trends will continue into the future. So if we pose the question, “What will a 2% bond be worth in a 5% world?,” most people can’t even conceive of the possibility of 5% interest rates. While everybody seems to understand that the stock market goes up and down, few seem to remember that the bond market also goes up and down.

As inflation begins to pick up, investors may be leery of owning 2% bonds that are going backward in purchasing power. If the sellers come out, bond values may decline while interest rates go up. The more selling, the greater the losses, which produces even more selling.

We are not predicting this will happen. But we do know a similar situation happened in the past. Fortunately, we are working on ways to preserve capital without facing the large risk from rising interest rates. If you would like to know more, please call or email us.

1Data from St. Louis Federal Reserve

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.