So you thinks Bonds are SAFE?

Regulator's caution speaks volumes about bleak prospects for debt investors

Once again the Feds at their last meeting agreed not to increase interest rates and hold interest rates at bay since the economy is not strong enough yet. This brings to mind the fact that many of my radio callers or people who attend our workshops, when asked how safe their portfolio is, refer to having bonds or bond funds as a large portion of their portfolio as a sign that they are not being too risky and assume that bonds are a “safe” investment. I beg to differ.   

A warning FINRA issued to investors back in Feb. 17, 2013 about the risks in bonds is still timely and still reflects the fact that according to the industry regulators, bonds are far from being safe.    The Financial Industry Regulatory Authority Inc. told investors in the alert it issued that in the event of rising interest rates, “outstanding bonds, particularly those with a low interest rate and high duration, may experience significant price drops.”

Other big investors at the time ranging from Bill Gross, co-founder of Pacific Investment Management Company LLC who was manager of the world's largest bond fund, to Jim Rogers, who was chairman of Rogers Holdings, as well as The Goldman Sachs Group Inc., already have warned that risk in the bond market. According to the alert, posted on FINRA's website, a bond fund with a 10-year duration will decrease in value by 10% if rates rise 1 percentage point.

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I often meets investors who don't realize they can lose money in what they think are safe bond funds.We see it all the time. We see bond funds with 5% yields and go through the holdings and see this awesome 'other' category of holdings that are difficult to evaluate. I think the FINRA warning from 2013 is helpful but he said the regulator could be more aggressive about warning investors off risky, complex products. FINRA urged bond fund investors to check on the duration in the product's fact sheet, and said individual bond investors can check with their investment professional, the bond's issuer or use an online calculator to get the figure. The FINRA alert points out that not even short-duration bonds are free of risk. “Bonds and bond funds are subject to inflation risk, call risk, default risk and other risk factors,” the warning said.