Low Interest Rates Hurt? Reality Check

Sep 24, 2011 in Bonds

One thing we hear is that today’s low rates are bad for savers that own bonds.    What?    Last time I checked, a nice return is good for a saver.



Bonds do not return just their stated yield-to-maturity (unless it’s both a zero coupon bond and held to maturity). As any credible fiduciary is well aware, there has been significant appreciation in the prices of various bonds recently.    Any bond-market investor is sitting on a strong return right now.

Complaining about low yields is a bit odd.    It is a lesser version of having owned Apple all the way up and then complaining that the market cap is so high it leaves little room for more upside. Reality check -- already made an outsize profit.   Low yields now mean that bond investors just made a lot of money on the capital appreciation side. People barking at Bernanke for keeping rates low and not allowing savers to make money is almost comedic --- the YTD total return of IEF is +14.7%.    Maybe savers should celebrate by getting their duration down and be happy with making 2 years of 7% return in just the last 6 months.  Perhaps they should consider gradually moving towards lower credit-quality bonds --  where rates have gone UP recently, not down.    Markets are dynamic, smart rotation is necessary to achieve a good return.

It seems to us that a stunning amount of investors just don’t understand the bond market. It is not a monolithic market that can be summarized with mentioning the current 10-year treasury yield.   Bonds with very long maturities are risky --- they are often more risky than a typical stock index.   Look at EDV or ZROZ or TLT--- these funds are extremely volatile. Just because they are labeled bonds absolutely does not make them conservative investments.Conv ersely, ultra short-term bonds have no sensitivity to interest rates -- they mature so fast that higher rates means higher re-investment rates for these maturing bonds --- these funds have obviously not appreciated much this year.

We like focusing mostly on the intermediate duration segments.   You get all the non-correlation benefit when things like equities are not attractive (like recently)--- you also get a decent lower-risk return while you wait for this equity market downtrend to run its course. And perhaps most importantly, short and intermediate bonds won’t get the large drawdowns when TLT and other long-duration bonds eventually tank (yields rise).

See also:

Yield To Maturity Charts Don't Tell The Full Story


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