We believe that today could be the riskiest time ever to own long term bonds. Since the early 1980s, bond investors have been the primary beneficiaries of a trend that has been in the making for 30 years – declining interest rates. Long term bonds, such as the 10 Year Treasury Note, yielded more than 15% in 1981. As of the end of August 2012, the same bonds yield just over 1.5% (Source: Bloomberg). Long term bond investors were able to lock in relatively high interest rates during this period and watch those high coupon payments benefit their portfolios.
With yields on long term bonds hitting record lows this year, that trend may be coming to an end. The coupon payment on the 10 Year Treasury note issued in August is just 1.625%, so the potential for high returns in long term bonds is very low indeed (Source: U.S. Treasury). Another concern for bond investors is risk – investors have traditionally looked to bonds to help provide stability to their portfolios. It is possible that bond investors are faced with unusually high risk today.
To find out why bonds may be riskier today than they have been historically, let’s use the example of the 10 Year Treasury Note. The primary source of risk for this bond is an increase in bond yields, because rising bond yields cause bond prices to decline. For the 10 Year Note issued in August with a coupon payment of 1.625%, an increase in yield of just 1% higher than the coupon would result in a yield of 2.625% and a decline in price of over 8%. A loss that large would require over three years of earning the new, higher yield for the investor to break even.
Long term bonds were not always this risky. In the past, higher yields and coupon payments afforded investors much more wiggle room to recover quickly from price losses when yields rose. We looked at some of the 10 Year Treasury Notes that have been issued over the past 30 years and looked at the relationship between how much their prices would have fallen from a 1% rise in yields and how long it would take to recover that price decline. Today’s figure of over three years to recover losses is unprecedented. We believe that this could well be the riskiest time yet to be a long term bond investor.
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Please remember that different types of investments involve varying degrees of risk, including the loss of money invested. Past performance may not be indicative of future results. Therefore, it should not be assumed that future performance of any specific investment or investment strategy, including the investments or investment strategies recommended or undertaken by RegentAtlantic Capital, LLC (“RegentAtlantic”) will be profitable.
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