It happened again.
The talking heads couldn’t contain themselves after remarks by the Fed chairman and now, several months later, investors are paying the price.
Well, maybe not all investors. If you’re a professional bond trader or mutual fund manager, you may have profited. But for individual investors who succumbed to this short-term thinking, the results were grim.
Considerable consternation
For background: In February, Fed Chairman Alan Greenspan sent the Treasury bond market into a tailspin when he said the Fed no longer intended to keep short-term interest rates at 1% for a “considerable period.”
At the time, the vast majority of TV talking heads and Wall Street “pundits” advised investors to either sell their bonds and flee to the money market or replace their long-term bonds with bonds maturing in five years or less. The phrase “rising interest rate environment” became a permanent part of the economic vernacular.
Of course, there’s no way to predict the future. But as we said then – and as we have said for more than 30 years in the business – if you’re an individual investor looking for income, stay the course and continue to buy high quality, long-term bonds.
We reasoned that this strategy would provide 50% to 75% more reinvestable income than short-term bonds, and this additional income would be available to purchase bonds at higher interest rates if they did indeed materialize. We also suggested that once the Fed began pushing up short-term rates, yields on longer-term bonds would stabilize or even drift lower.
When cash is not king
Unfortunately, investors who decided to wait for higher rates before committing funds to the bond market are finding the “cost of waiting” to be prohibitive.
In fairness to the Wall Street seers, some interest rates did rise. The 10-year Treasury rate, on which the media obsesses, shot up to a peak of approximately 4.88% in May from 4.24% at the beginning of the year. Now, just 3 ½ months later, that same 10-year note is yielding less than 4.15%, leaving it below where it began the year.
So, if you are a professional bond trader or mutual fund manager, you may have been able to profit from this short-term volatility. Long-term municipal bond yields, on the other hand, barely moved up during this period and are now starting to decline.
To their credit, most veteran municipal bond investors are rarely influenced by Wall Street gurus, who claim to be proponents of long-term investing, while continually recommending “turn on a dime” changes in asset allocation.
The cost of waiting
Newcomers to the bond market, influenced by the Wall Street “gurus” who are woefully inadequate at discerning the difference between traders and investors, have once again been done a disservice.
If municipal bond yields jumped to 5.50% on Jan. 1, 2005, it would take more than 10 years to equal the income from the 5% bond they might have bought in January of this year.
High quality tax-free bonds are still available with tax-free yields in the 4.75% to 5.00% range. They provide excellent value today, when compared to 30-year Treasury bonds yielding less than 5.00%.
Remember, if you are seeking capital gains, look for them in the equity portion of your portfolio. When it comes to tax-free income, utilize the magic of compounding and keep your interest clock ticking.