Labeled by the financial industry as a “flight to safety”, many members of the Baby Boomer generation now find their personal investment portfolios heavily laden with US Treasury Bonds. Fleeing from the ever increasing volatility of the stock market, investors have taken comfort in the total returns offered by bond purchases over the last ten years. As yields on the thirty year Treasury settle in near the 3% mark, is it time to unload?
Evaluating the Risk
As of October 3, 2011, the 30 year US Treasury had a yield of 2.76%. In order to evaluate the impact of rising interest rates on future valuation, we will assume the purchase of a newly issued bond with a par value of $1000. While no person can predict the precise movement of future interest rates, for sake of comparison, we will use the actual interest rates taken from historical data ten years earlier. In this case, we will use 5.39%, the rate as of Oct. 1, 2001 for the twenty year maturity.
Ten Years Later
Fast forward to 2021, investors who purchased a 30 year Treasury would still have 20 years until maturity. As they open their brokerage statements, they find their bond to be valued at roughly $682, in order to bring the yield in line with present day new issues. That would be a loss of $318 in value, offset by the receipt of $276 in income generated over the course of holding the bond for 10 years. Total impact to the investor in this scenario would be a net loss of $42 for tying their money up for ten years, how’s that for total return?
“Say it ain’t so”
Sure, this hypothetical makes big assumptions, and interest rates could still be much lower than the 5.39% used to arrive at a loss of $42 by the time 2021 gets here. At the same time, this hypothetical does not even begin to factor in the S&P downgrade of US debt earlier this year either. For concerned investors, search the internet for a good bond calculator and use your own assumptions of what the future may hold for the bonds in your own personal portfolio. For those using full service brokerage accounts, call your advisor and have them walk you through it, that’s why you pay them those higher fees.
Don’t become emotionally attached
After evaluating your portfolio, remember to not become emotionally attached to those investments that have made you money in the recent past. If you were an investor smart enough to follow the “flight to safety” into the bond market, make sure you know when it’s time to “fly the coop” too.