63% of American Investors Don’t Know…

Posted by on May 23, 2013

I had the opportunity to spend a couple days back in the concrete canyons of Wall Street this past week talking with some strategists and market gurus. Even though the market again didn’t do much again in this week’s sessions, I want you to know that I made sure that they all understood that they are to keep the markets moving higher for us for some time to come. I know they really will because they each said, “trust me” when I asked for confirmation of that message…

The one point from the meetings that pretty much summarized all their thoughts was best stated by Sam Stovall, the chief equity strategist for S&P. He said that, “global economic indicators show growth slowdowns ending no later than this year’s fourth quarter.” I think some of that was evidenced by a couple reports this week. We saw the index of US leading indicators rise by the most in three months, (1) together with the Eurozone flash manufacturing PMI increasing to a 26-month high. (2)

By the way, Sam added that we’re now moving into the fifth year of this bull market and, according to the S&P data, the average S&P500 gain in this part of a bull run has been 24%…not without intermediate fluctuations, he did say. I’ll settle for average, in this case.

What don’t they know?

According to a new study by brokerage firm Edward Jones, 63% of Americans don’t know how rising interest rates will affect their retirement portfolios – their 401(k)s, IRAs, et al. By age, one-third of those surveyed between 18 and 34 said they have “no idea” about this. One quarter of those 65 and older had the same response. (3)

This is not good as ignorance is definitely not bliss. Their risk of losing money due to the rising rates is increasing steadily and they have little idea it’s happening. The simple reason is what I choose to call “bond math.” It works like this.

Bond prices and the values of investments holding bonds, i.e., bond funds, tend to move in the opposite direction of interest rates. For about the last 30 years – over a generation – bond rates have been steadily moving lower…even more so with the Fed’s easing. So, investors have seen their bonds hold their values over most of that period and have come to assume they offer little risk of loss. As a result, these folks have been pouring money into all types of bond funds in massive quantities.

How massive? According to AMG/Lipper, in November, 1991, there was about $250 million invested in taxable bond fund assets. By November, 2012, that was up to over $350 Billion! I call that balance really massive and, worse yet, most of that is in the retirement plans owned by the 63% referred to in the report.

It started this past May

Bill Gross, the manager of the PIMCO Total Return fund, the world’s largest bond fund, said this on Twitter on 29 April this year. He said, “The secular 30 year bull market in bonds likely ended.”

In early May, the 10 year US Treasury Note was bid at 1.63%. (4) On Thursday, it got as high as 2.92%. The 10 year is now returning what the 20 year bond did in June and what the 30 year bond did in May. (5) These are major percentage moves.

A look at bond fund values on your statements will likely show price drops since May. The bonds and funds with the longest durations are the ones which will have the largest losses. This movement has nothing whatever to do with the quality of the holdings. It’s just the “bond math.”

Many investors, regardless of age, annual income, education, gender, whatever have come to think of bonds as risk-free – especially Treasuries – and that they would never see a drop in those holdings. The only thing risk-free about Treasuries is their lack of default risk; something that has nothing to do with market and principal risk.

What do they need to know?

The 63% need to understand that bond funds can, in fact, lose money. Since the focus of this report was on retirement funds, they also need to consider the effect of this over their entire retirement. According to BlackRock, today’s Boomers can expect to spend 20 to 25 years in retirement. It’s likely younger investors will have even longer time. Watching the steady erosion of your primary asset base and not taking remedial action is not a good idea. A review of those holdings now is to their definite benefit.

I don’t think rates are up because the market is worried about a tapering of quantitative easing (QE). Rates are moving up because both the market and the Fed are realizing, as Sam and the others in New York suggested, that the economic fundamentals are improving. Rates are simply normalizing. Additionally, higher rates come as a direct result of stronger economic growth.

If the economy does pick up, I think we could see the 10 year rates move to 3.5% or even 4%…more in line with what the economic growth would warrant. Good for the overall economy – not so good for overly-allocated bond holdings.




Securities and Investment Advisory Services offered through KMS Financial Services, Inc.

  1. Conference      Board, 22 August 2013
  2. Markit,      22 August 2013
  3. Edward      Jones, 21 August 2013
  4. US      Treasury, May 2013
  5. US      Treasury, August 2013To get an overview of economic      conditions, use this link. It’s updated monthly.


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Michael J. Maehl, CWM®

Senior Vice President

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