Tags: bond | losses | inflation | rates

Bond Investors Face Guaranteed Losses When Rates Rise

Friday, 26 Oct 2012 07:39 AM

By Michael Carr

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Over the past 15 years, investors have suffered devastating losses twice in the stock market, and many are still reeling from declines in the values of their homes. Understandably, many are seeking safety and in doing so may be setting themselves up for yet another large loss.

Since late 2008, investors have added more than $1 trillion to bond funds, according to Morningstar. However, those investments are guaranteed to lose money when interest rates rise.

Goldman Sachs Asset Management recently estimated that 10-year Treasury notes decline about 6.6 percent when interest rates rise by 1 percent. High-quality corporate and junk bonds will fall even more than that when rates rise.

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For now, rates are low because the Federal Reserve is buying. Through various quantitative easing programs, the Fed is adding more than $1 trillion a year to the economy and has told investors that it expects to continue doing this for at least the next two years. If the Fed reduces its buying, rates could rise.

Rates could also rise if inflation increases or if bond-market investors even expect inflation to increase. For now, everyone agrees that slow growth and high unemployment will prevent sustained inflation. If that changes, bond investors will lose.

Fixed-income investments might sound safe, but investors should understand they are locking in losses if rates rise. These losses could quickly become another double-digit setback for retirement accounts.

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