Don't Blame the Fed for Your Own Investment Mistakes

What's worse than making bad investment decisions? Making bad investment decisions and then blaming it on the Federal Reserve.

For almost a decade now, I've heard a variation of the same line: "Because of low interest rates, the Fed is forcing me to buy _____."

"The Fed Is Forcing Investors Back Into Stocks," writes Yahoo! Finance.

"The Fed Is Pushing Investors to Buy Junk Bonds," warns CNBC.

"Lower short-term rates have the effect of forcing investors to reach for income by lengthening the maturities of their portfolios and by taking on more risk," writes US News.

Oh, please. 

Low interest rates make it tempting to buy riskier assets, since that's where you can find respectable yields. But the Fed isn't forcing anyone to do anything. You can make (or decline) any investment you want, at any time, for any reason.

There's that classic mother-and-son scene where a mom is scolding her son for doing something bad. "But mom, Jimmy told me to do it!" the kid explains. "And if Jimmy told you to jump off a cliff, would you do that, too?" The mom asks.

"No, Mom, I'm not an idiot."

The relationship between you and the Fed is the same. You should never take risks you can't afford. It doesn't matter what the Fed is tempting you to do. If it's a bad deal, don't do it.

After the housing bubble burst, one of the standard lines of finger-pointing was that low interest rates forced investors to reach for yield, since they couldn't make enough money on Treasuries anymore. Back then, that meant buying subprime mortgage bonds. You know how the story ends -- many of the subprime bonds were soon worthless (Treasuries, ironically, have done extraordinarily well since).

The Fed made huge mistakes last decade. But no one was forced to reach for yield. No one was forced to buy subprime bonds.

Some would say, "But I needed yield. What choice did I have?" Well, how good did that extra percentage point of yield you earned in 2006 taste after your initial investment had gone up in flames by 2007?

It's similar today. With Treasuries yielding close to nothing and high-grade corporate bonds not far behind, investors have plowed into junk bonds with a passion. Junk bonds now yield what 3-month Treasuries yielded 12 years ago. In January, the market-weighted average junk bond traded at a 5% premium to par value, according to FridsonVision. With junk yields so low, it's nearing a lose-lose proposition, as the Financial Times pointed out: "If the economy deteriorates, the rising probability of default could cause spreads to widen. If the economy improves, yields would rise -- and prices fall -- for all manner of fixed-income securities."

The usual response from investors participating in this insanity is that junk bonds are the only place you can find yield these days. But if you think earning low yields in safe investments is bad, wait until the air comes out of the junk bond market and you lose a big chunk of your principal. It'll hurt a lot worse.

I think what this comes down to is short-term thinking. Being hungry for yield and running into junk bonds might make sense if you're only thinking about the next few months or the next year ahead. But if your investment time frame extends any longer, the odds increase that you are taking risks that far outweigh the rewards. Get a little bit extra yield today, pay a big price tomorrow.

When the tide turns, don't blame the Fed. Blame yourself. 

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics. 


Read/Post Comments (17) | Recommend This Article (20)

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  • Report this Comment On February 23, 2013, at 1:38 PM, smartmuffin wrote:

    Can I still blame them for intentionally inflating the housing bubble? What about causing the business cycle? How about the fact that the dollar has declined in value by 97%?

  • Report this Comment On February 23, 2013, at 3:59 PM, ACM666 wrote:

    Hilarious..."Jimmy told me to do it." I agree!

    Ben didn't tell investors to seek yield, he just - via low interest rates - told them that if they didn't seek risky yield that they'd quickly cross the bridge into poverty, riding shotgun in a pickup truck being driven by our friend Crip 'D - or as most of us know him, Crippling Deflation.

    Most "smart" investors should've been like...no way Ben! I'm going to put my money under a mattress until this whole thing blows over! Forget that gas has quadrupled in price, the average trip to Wendy's for a family of 4 now costs $30, or that income/property/sales taxes have increased substantially across the country. Forget that the stock market has risen ~100% since its '09 lows...ain't nobody gonna tell me where to put my cash.

    Great article.

  • Report this Comment On February 23, 2013, at 9:14 PM, Darwood11 wrote:

    Yes, no one forces anyone to make any specific investment.

    Or, for that matter, to buy more house than they could afford. Or to buy that new car every three years, or buy a new iPhone every time the latest permutation is released.

    I sometimes think I'm in the wrong place. I'm investing for the long term. I'm saving and investing to build a nest egg designed to last 35-40 years in retirement. I'm investing to beat inflation, and to financially thrive. However, investing is simply one piece of the financial puzzle. To invest means spend less than one earns, a lot less. Save the rest and then put that somewhere where it will grow and do what one can to legally avoid the tax collector.

    I'm not a gambler and I'm not investing to get rich. If that will happen, it will be strictly by accident. Getting rich is not expected.

    Obviously, I just don't get it as an "investor." I'm doing my best to ignore the claptrap and stuff that Ben and that band or renown in Washington keeps throwing my way.

    The one thing I know I can count on is they will screw it up, and I'd better have a program in place to deal with the consequences. That means be flexible and avoid pitfalls and don't make stupid mistakes. It also means save more than the current tables would indicate.

    There were a lot of people a few years ago who jumped on the "retire early" bandwagon and expected their home to continue to appreciate at double digit rates, their savings to earn 5-8% into the horizon, and so on. Rosy projections are dangerous.

    There is a pragmatic line to be walked between rosy and pessimistic.

    The best way to do this is turn off the boob tube. Don't listen to the talking heads, Remember that the politicians are not my friends and be fully and completely aware that these decisions and choices are mine and that I alone am responsible for my well being.

    Or I can climb up on the roof and wait for the cavalry. It didn't happen in New Orleans after Katrina, and it won't happen today is my mantra. . At most, I might be a convenient sound bite for some politician and a photo in a tabloid.

  • Report this Comment On February 23, 2013, at 9:18 PM, whereaminow wrote:

    This is an interesting article for you Morgan.

    1) You imply, nearly admit, that the Federal Reserve's interest rate targeting causes market disequilibrium. If you openly stated that, you would be at odds with most mainstream economists. That's not your style.

    2) More importantly, how do you rectify this position of "you should know better" with your previous support for the bailout?

    Specifically, you write:

    ---> one of the standard lines of finger-pointing was that low interest rates forced investors to reach for yield, since they couldn't make enough money on Treasuries anymore. Back then, that meant buying subprime mortgage bonds. You know how the story ends -- many of the subprime bonds were soon worthless <-----

    So the investor who buys a subprime mortgage bond is a fool who needs to take his medicine when the losses occur, but the banks with armies of economists and analysts deserve to be bailed out?

    How do you simultaneously hold those two beliefs?

    Interestingly, I saw you recently wrote an article in which you implied another round of bailouts was heading our way, and that you probably wouldn't support them.

    It seems to me your setting yourself up for an "I told you so" when the new asset bubbles crash, without acknowledging that the first bailout was a mistake.

    One last thing. If you can't blame the Federal Reserve, which actively manipulates the interest rate and has regulatory authority over every investment a bank makes, then what can you blame them for?

    You wrote:

    ---> The Fed made huge mistakes last decade <---

    Incorrect. The Federal Reserve's existence is a mistake.

    David in Liberty

  • Report this Comment On February 23, 2013, at 9:50 PM, NickD wrote:

    It's scary to see 17 million drop to 11 million but were back up didn't invest in solid companies for 37 years to panic and bail

  • Report this Comment On February 24, 2013, at 11:58 AM, CathrynMataga wrote:

    Lately, mostly bonds or stocks, whatever you had is basically good. All the people who lost serious money bought Apple, Can't blame the Fed for that.

    With bonds, really, it seems to me this is just like any other loan. It's all about a fund that does it's homework and keeps an eye on what's going on in the companies they're lending to.

    Put it in perspective, with equities the risk is always going to be much worse than owning the debt. When the big bad comes, the debt gets paid first, then equities get whatever scraps are left.

  • Report this Comment On February 24, 2013, at 4:06 PM, SkepikI wrote:

    ^ CathrynMataga: "the debt gets paid first, then equities get whatever scraps are left" Sort of. That used to be true - you might want to re-examine that belief in light of what happened with GM and others.

    And consider this risk for debt- when its yielding 2 % or less, and values fall 4% because rates went up, while stocks are not only yielding 3% or better, plus climbing....where is the risky bet then? We had some hints of that in the past few weeks, with bond funds declining 1-1.5% in value when they are only producing 2%.... risk is relative to the environment you find yourself in... its never absolute.

  • Report this Comment On February 24, 2013, at 4:11 PM, damilkman wrote:

    I believe the author skipped a more interesting concept. There is a group of investors who in the past relied on interest on bonds to generate their income. Is not the old tried and true mantra that when you retire put more money into bonds because you need the safe and solid investment?

    I will not be as strong worded as David in Liberty but I agree that much of the problem are distortions by the Fed that have debased the value of capital. What once could command a 6% return might not get you 3%. If you can't live on a 3% return and cannot afford to dip into your net worth then what is the solution?

    To me the biggest failure of the Fed is to increase the scope of uncertainty. I understand that nothing is completely certain. But by reducing the value of capital an entire class of investor that would have been just happy to take their yield on a boring safe bond has to scramble for an alternative. The author correctly points out implicitly that each of us is responsible for their decisions. But I can still blame the Fed for producing the environment that induced those investors into that mistake. Yes, the drug dealer is also culpable even if the user must take responsibility.

    This leads to the last point if you were one of these people that relied on a decent return on bonds in the past, what is the author's suggestion? How do you generate modest income in a risk adverse way without losing your shirt?

  • Report this Comment On February 24, 2013, at 7:30 PM, SkepikI wrote:

    ^ The simple answer is the least satisfying....understand the risks and behave appropriately. If the Fed is artificially REPRESSING interest rates and bond yields, and you understand this then you understand the risk of loss you are running. Its not a game you MUST play in particularly when its only paying 1 or 2%. I do not consider that adequate nominally, let alone "risk adjusted" for the coming value drop in the bonds. When will it come? who knows, but its inevitable even if it takes a long time. And of course the Fed can keep this up a long time. But there are less risky alternatives in the short run while you wait for the fed to stop... shorter term, for one, so if the price does drop, you can minimize the hit. Not enough you say? Some really secure, large cap well positioned stocks pay 3% or more. Risky? maybe, but not as risky as bonds right now. Risk is relative to where you are.

  • Report this Comment On February 25, 2013, at 1:13 AM, CathrynMataga wrote:

    The thing is rates will rise if the economy starts to overheat and the Fed needs to slow things down, but right now that's so hard to imagine. Personally, I'm betting on the fiscal cliff, the sequestration and all this will be deflationary. I want to see the results of the first set of cutbacks, and tax increases first.

  • Report this Comment On February 25, 2013, at 8:57 AM, TMFGortok wrote:

    In a world without the Federal Reserve, hopefully interest rates would be set by the market; or even better, money would be backed by something more than 'the full faith and credit' of an entity that frequently 'revises' and changes things to suit its own political whims.

    People think gold bugs are crazy. I think relying on a political entity for something as important as the value of your money is crazy.

  • Report this Comment On February 25, 2013, at 9:06 AM, TMFGortok wrote:

    Morgan,

    I love your articles because they take a unique approach to defending mainstream views.

    While your article does rightfully point out that we have free will, it misses the point of the problem with the Federal Reserve manipulating interest rates:

    It hides the true cost of political decisions, and it goes so far as to enables risky decisions made by our politicians. I'm thinking specifically of the decade's past wars, but this can be applied to a whole host of decisions made by the President and the Congress.

    If the President had to fund our wars through taxation, do you think the American people would allow it to have gone on for over a decade? If interest rates were not set (or manipulated) by the Federal Reserve, do you think the government could have continued their decade of binge spending?

    To imply that the Federal Reserve's actions should not influence the actions of political entities is asking a bit much. Especially if those politicians find themselves funded by the very groups that benefit from an easy money policy: The military industrial complex and Wall street.

  • Report this Comment On February 26, 2013, at 9:41 AM, Stonewashed wrote:

    You're right, no one makes me buy the junk they're selling. On the other hand, when junk is the only thing being sold, proftis are fiction, rating agencies are mere madaams for Wall Street's stable, and virtually make it impossible for retirement money to be invested outside their stable, that's not only a joke, it is callous, haughty, and thuggery at its very best. Moreover, "trust us" and our casino with your money and maybe, if your lucky, you will beat the odds, If not, we'll just nibble away at the principle until it's gone (if you live long enough). In the mean time, we'll rewrite the laws to keep your heirs from getting it, should you outlive it. Oh, and let's not forget, The Fed will charge their management fees on how much they are managing, not how well they are managing it, as will the investment banks make their money on fees, not how well they manage your money. Good work, if you can get it.

  • Report this Comment On February 26, 2013, at 1:51 PM, wasmick wrote:

    "People think gold bugs are crazy. I think relying on a political entity for something as important as the value of your money is crazy."

    What's the difference?

    And just in case you're wondering, this is a sincere question, not trolling.

  • Report this Comment On February 27, 2013, at 12:56 PM, TMFGortok wrote:

    @wasmick The difference is that with Gold, there is a finite, stable supply of gold in existence. The amount of gold in existence does not expand and contract at the whim of a political entity. That means that a dollar bill will always have a (near) constant buying power.

    Ten years ago, you could buy a candy bar for 69 cents. Now, that same candy bar (actually, a slightly less weighted candy bar) costs 99 cents. To lose 30% of value in the dollar over 10 years is huge, and I bet the income of a non-skilled worker hasn't increased by 30% over the last ten years, has it?

    Inflation hurts people who have fixed incomes, and it hurts those of us who aren't politically connected enough to be the first to receive the money (e.g., big banks). By switching to a gold backed dollar standard, we take away the ability of the Federal Reserve to print money whenever they want.

    Incidentally, this also has other side effects: If the government wants to engage in deficit spending, then they must raise taxes or issue bonds that are available on the open market (and not purchased by a central back, since in this scenario, we wouldn't have a central bank). It's a built in "don't screw with future generations" tool.

  • Report this Comment On April 06, 2013, at 2:47 PM, JoeMiddleclass wrote:

    Folks this is our fault. 100% our fault. When are we going to have a ten million Americans march on Washington to end this rape? There are 300 million Americans, most in the rapidly declining middle class. There are about 100 Senators and 435 Congressmen. That means we outnumber these self serving pigs by about 60,000 to 1, yet we only complain while they vote totally destructive funds and pork to themselves and cronies, create wars, fund dead companies, (can you say Solyndra), feed banks that hoard the money, allow a 95 increase in CEO pay, allow huge companies and the rich to avoid taxes and pay for their excess self serving greed and spending recklessness with our dwindling Health and retirement while they vote themselves untouchable gold standard perks in retirement and health and throw us the bones. Then they run up the Debt into the stratosphere, ruin the middle class, destroy jobs and now want to attack us again with lowering our standard of care and retirement. Basically I believe they want us to die sooner than we might by cutting off our supply. WHEN ARE WE GOING TO STOP BITCHING AND SAY NO!!! When are we going to go to Washington, Middle Class strong and say either you join us in the programs we have or we throw you out and find someone that will honestly and caringly serve us. Since when does the employee get better perks than the employer?? Wakee, Wakee. Let's do this and soon while we still can!!!

  • Report this Comment On April 06, 2013, at 2:54 PM, TMFMorgan wrote:

    <<To lose 30% of value in the dollar over 10 years is huge, and I bet the income of a non-skilled worker hasn't increased by 30% over the last ten years, has it?>>

    Yes. In fact, it has (29.9%, to be exact.)

    http://research.stlouisfed.org/fred2/data/CEU0500000030.txt

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