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Monday, 11 February 2013 04:08

Investing in Bonds - the Safety Trap

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Following the Global Financial Crisis many investors have fled share markets for the safety of Government Bonds and now safety has never been more expensive, or dangerous.

This can be seen in fund flow figures that show (blue bars) that investors have withdrawn money from share markets since 2008 and heavily invested into bond funds since that time.

Bond Fund Flows

In Australia the 10 Year Government Bond yields are around half of what they were before the GFC, as is the case in the US.  The chart below shows the income yield for 10 year Australian Government Bonds.  The key point here is that there is an inverse relationship between bond yields and bond prices, in that as yields fall, bond prices rise.  Conversely as bond yields rise, bond prices fall.

10 Year Govt Bond rate

In other words, as interest rates on Government Bonds rise, investors in those bonds stand to lose capital.

How much do interest rates have to rise before investors start losing money?  The table below is sourced from the Wall Street Journal and shows that investors in US 10 year Government Bonds (yield at the end of 2012 was 1.84%) would receive a negative return this year if the yield rose to 2.23%.

BF-AE255_BONDFU_G_20130125155710

And just how much could investors lose long term interest rates rise on Government Bonds?  The chart below calculates the impact on bond prices of rising rates in various scenarios.  The dark blue bar shows the value of a bond at current interest rates.  The mid blue shows the value of the bond should rates rise by 2% and the lightest blue shows the value of the bond should rates rise by 4%.

Bond Loss

The message is clear - investing in bonds right now has never been more dangerous and now is the time for investors to review these investments.

This material has been provided for general information purposes and must not be construed as investment advice. This material has been prepared without taking into account the investment objectives, financial situation or particular needs of any particular person. Investors should consider obtaining professional investment advice tailored to their specific circumstances prior to making any investment decisions and should read the relevant Product Disclosure Statement.

 

Read 894 times Last modified on Friday, 15 February 2013 20:08

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