FOOL ON THE HILL
When the Treasury killed the 30-year bond recently, investors wondered what it meant for them. It's a good prod to make sure your short-term money is in a safe place, as well as to examine any opportunities in a low-inflation and low-interest rate climate to buy a home, refinance a mortgage, and check out possible high-yield stocks.
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When the Treasury Department recently announced that it would discontinue selling government bonds with 30-year maturities, I'm sure all of you raised your wrist to your forehead and exclaimed, "They're killing the long bond. Oh no!" You didn't? All right, we can burn that strawman right now. Despite media reports, the death of the long bond means nothing directly, but it's a good spur for you to check your financial house for two simple things: First, don't confuse your short-term savings with money for long-term investment purposes. Second, if you really want income from your investments, avoid an ill-conceived rush into bond funds and consider high-yield stocks. What did Treasury do? That's most likely because the government no longer needed to entice investors with such a long maturity. The cost to the government of any debt is its interest rate, and that varies according to future inflation expectations, because investors want at least some kind of return above the inflation rate. Not only that, but they demand a higher rate for a longer term, because the longer the horizon, the harder it is to predict the inflation rate. One of the great achievements of the Federal Reserve beginning with Paul Volker's chairmanship and cemented with the first Bush Administration's tax increase and the Clinton Administration's early budget victory, was bringing down inflation expectations and thus lowering the cost of both public and private borrowing. Should that ever change, Treasury has the flexibility to offer 30-year bonds again. It means in the short term that the money that would have bought those bonds now must go elsewhere. This may mean a flow into the 10-year bond, which would raise the price and lower the interest rate (bond yields vary inversely to price). Because banks often peg mortgage rates to the 10-year bond, mortgage rates may decline, buying a home may be easier and refinancing your mortgage might save your money. Others also apply an old saw, "don't bet against the Fed." That means that when the Federal Reserve lowers interest rates, at some point it lowers other interest rates on investments so that investors seek higher risk-adjusted returns elsewhere. This is one of those chicken-and-egg thingies. The Fed may lower interest rates to increase liquidity, but it does so only as long as it believes that inflation is not a threat. Other debt issuers watch the inflation figures too, and they then price their debt with lower interest rates -- not just because of the Fed action. The theory goes that as investors allocate their capital among investments according to risk, they may choose to put more into stocks when fixed interest investments are paying less. Remember the high-inflation late 1970s and early 1980s? (I'll never forget a friend's new mortgage at 18%, because that was before I knew you could refinance!) Many people decided to stick with double-digit interest through their money market accounts rather than invest in stocks, even though inflation was eating up the returns. Then, when the Volker and Greenspan-led Federal Reserve acted to bring down inflation and inflationary expectations, investors desiring higher returns above inflation had to look elsewhere and take on more risk -- in stocks, driving up prices. Again, that's the theory. It doesn't matter to the long-term investor, who knows that interest rates will rise and fall, and money in the aggregate will flow into stocks and out, just as the tide ebbs and flows. The long-term investor does not ask why, knowing that even the wildest periods of late 1970s inflation and interest rate hikes didn't last. But stock and bond markets can react violently in the short term, and investors are at risk if they put funds into the stock market that they will need in periods of five years or fewer. That money -- money you absolutely will require for any essential purchase within that time -- should not be in the stock market, due to the wide variation in short-term returns. That money belongs in any of several different options for short-term savings. With your short-term savings, pay close attention to what you think is a fixed-interest, low-risk interest-bearing account, so that you don't buy what turn out to be certain kinds of bonds that expose you to short-term price risk from interest rate swings. Bonds funds? For one thing, they haven't the slightest idea what affects bond prices -- and yes, some bonds are bought and sold in a market where prices fluctuate. The mutual fund group American Century found through a telephone survey that only 31% of 750 investors knew that bond prices vary inversely to prevailing interest rates. Gulp. Just remember "hi-lo." Price higher, rate lower. Or, rate higher, price lower. Because interest rates have fallen, bond prices have risen. When interest rates increase again, as they almost certainly will barring a Japanese-style decades-plus period of deflation, bond prices will decrease, so that new buyers will earn the prevailing interest rate. So yes, Virginia, there is a risk to your principal when you buy and sell bonds. This is way too short to explain the ins and outs of bonds and bond funds, and besides, Robert Brokamp, who is not only knowledgeable but funny (where can I get some of that?), does so in clear language that makes me chortle in "Bonds vs. Bond Funds." To learn to avoid problems, check it out for how and when bonds and bond funds might be right for you, whether you're Elmer Fund or the Blonde Bondshell. High-yield stocks? For those with a fascination to learn about stocks -- to devour SEC filings, join in discussion board debates, and crunch some numbers -- high-yield stocks offer the chance to mix income with potential stock price appreciation. Especially with the growth of IRAs, individual investors may find some high-yield stocks that serve their needs. Jeff Fischer introduced their allure and identified six in a DRIP portfolio column, while Zeke Ashton not only analyzed high-yield stocks in-depth, but offered nine very intriguing stocks in our monthly stock publication, The Motley Fool Select. So do we care about the death of the 30-year bond? Nah. We like that it reminds us to makes sure we understand where our short-term savings are invested and to check out possible opportunities to buy a home, refinance our mortgage, or invest in high-yield stocks. It's not an onerous task, and we're here to help. Best Foolish wishes to all! --Tom Jacobs, TMF Tom9 on the discussion boards
Wish you had a little help with your financial decisions... want a second opinion? TMF Money Advisor. Your Guide to Financial Peace of Mind. Get honest, practical advice from your own personal financial planner. No sales pitches. No pressure. Just helpful answers to your biggest money questions. Tom Jacobs (TMF Tom9) lives in Old Town, Alexandria, not far from Fool HQ, so he won't get lost on his way to work. At press time, he owned no shares in companies mentioned in this story. To see his stock holdings, view his profile, and check out The Motley Fool's disclosure policy.
The Treasury Department issues bills, notes, and bonds to finance federal government debt, which, even though the government has been running a budget surplus, still exists from prior borrowing. The bills, notes, and bonds vary in maturity from under a year to, until recently, 30 years. With all these different options, and with recent surpluses, the government determined that it didn't need the 30-year bond to keep our financial house in order.
According to people who watch these things, record amounts of money are flowing into bond funds -- funds that invest money in interest-bearing debt. In the short term, these prices can vary dramatically. And I'll go so far as to say that many individual investors are going to be as hurt by doing this during a period of market doldrums as they were if they bought high-flying stocks at the top of the 1999-2000 bull market height. Why?
For periods of 20 years or more in this century (more or less, depending on your study), stocks have outperformed every other asset class -- real estate, bonds, or baseball cards. Of course, not all investors have 20-year horizons. Some who are closer to retirement may be starting to adjust their portfolio mix of income-producing investments and stocks (see Robert's column). But all in all, stocks are where the long-term investor wants to be. For those who don't have the passion and time it takes to learn about individual companies, this means that their money belongs in a broad market stock index fund.
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