In the market fallout of 2008 and early 2009, we watched as many investors moved away from their stock and equity funds into bonds and bond funds. They then missed the subsequent run up in the stock market in 2009.
Bond funds have swelled in huge proportions over the last years for two main reasons. First, people moved into bond funds away from their money markets due to the low returns. Other people were tired to the stock market's downward spiral and ran to the bond funds for a safe haven.
Missed in the safe haven is the inherit risks involved with bond funds. This risk is interest rate risk. The price of a bond falls as interest rates rise. As of this writing interest rates are near 0%. The only possibility is for them to rise. So how much is at risk? Generally a 1% rise in interest rates leads to a 7% drop in the price of bonds. Therefore, a 4% rise in interest rates would lead to a 28% DROP in your bond values.Other "safe" spots for your money also have inherit risks you should be aware of. First are CDs. We have seen people deposit an amount in a CD equal to the amount of the FDIC protection (currently $250,000). This would leave no coverage on any interest you earn if the bank should go bankrupt. Don't think it can't happen to you, 59 banks went out of business last year.
Money markets dropped below the $1 mark in September 2008. As Lehman Brothers failed their commercial paper caused people to lose principal dollars. By chasing yield in your money market account, you are putting your principal at risk. Look for money markets that are based on US treasury notes. They may yield less, but are much more stable.
To hear the Smart Money Radio Show segment focused on this topic, Please Click Here! (about 7 minutes long)
To hear the full Smart Money Radio Show where Bruce discusses this topic and more, Please Click Here! (about 25 minutes long)
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