Bond Market Crash: Is Disaster Ahead for the 'Safe' Part of Your Portfolio?

Bond market crashJust when you've finally gotten over the stock market crash from four years ago, there's a new threat that could potentially hit your portfolio. Even worse, it's in an area that many people think of as being safer than stocks: the bond market.

Goldman Sachs (GS) is the latest big Wall Street institution to sound the alarm about a potential bond market crash. Although bond-market dynamics are sophisticated and complex, the argument against bonds boils down to these simple points:
  • Interest rates are near all-time lows, which means that the prices of bonds and bond funds, which go the opposite direction of rates, are extremely high right now.
  • Nevertheless, investors have piled into bond investments over the past several years, accepting lousy guaranteed returns in exchange for the near-certainty that they won't lose any principal.
  • Corporations and other borrowers have been issuing huge amounts of bonds into the market, raising cash and refinancing their debt to take advantage of low rates before the opportunity to get cheap financing disappears.
  • In the past month, rates have started ticking upward, and further rate rises -- which many see as inevitable -- would send bond fund prices down.
Even worse, many investors who've been trying to boost the income from their portfolios have unknowingly increased their risk in a potential bond market crash. Just as a five-year CD pays more than a one-year CD, longer-dated bonds have better rates. But their prices are also more vulnerable to interest-rate increases, magnifying their future losses if rates rise sharply. Brokerage firm UBS (UBS) even plans to take the extraordinary step of classifying bond investors as "aggressive" because of the firm's negative outlook for the bond market.

Where Can You Take Cover

Goldman and other Wall Street firms can use expert strategies and complex financial products like derivatives to give them protection against rising rates and falling bond prices. For regular investors, though, the options are more limited.

Here are some ways you can take cover if you agree that a bond-market crash is coming:
  • Think short-term. Investing in short-dated bonds reduces the interest rate you get now, but if rates rise, you don't have to wait as long before you get to reinvest in a new bond paying a higher rate. Bond funds that own short-term bonds also don't lose value in rising-rate environments as much as longer-term bond funds.
  • Look at CDs instead of bonds and funds. Bonds and bond funds can rise and fall in price, but with CDs, you always have the option of withdrawing your money simply by paying an early-withdrawal penalty. With some banks letting you take money out by paying as little as three months of interest, if rates rise dramatically, you can grab your CD money early and reinvest it in a higher-paying CD.
  • Consider inflation-protected savings bonds. One of the best deals in the market right now is the Series I savings bond, which pays returns based on the current rate of inflation. The rate changes automatically every six months, but you don't have to pay taxes on the interest until you cash them in. One caveat: you can't cash them in for a year, and if you hold them less than five years, you'll pay a three-month penalty. (By the way, don't confuse these with TIPS -- Treasury Inflation-Protected Securities. Series I bonds are similar, but not the same.)
  • Beware of high-risk bonds. The safest bonds tend to pay the lowest rates, with Treasuries at the highest level of safety and corporate bonds offering successively higher interest rates as credit quality weakens. Many investors have gravitated to speculative high-yielding "junk" bonds because they pay 6 percent or more compared to less than 2 percent for comparable Treasuries. But if those somewhat riskier companies default on their debt, you could lose much or all of your investment.
Experts have been calling for a bond-market crash for many years, and so far, their cries have fallen on deaf ears. With more signs pointing to a healthier economy, though, rising rates look like they're getting closer. Take these simple steps and you'll reduce your losses if a bond-market crash happens.

For more on smart investing:

You can follow Motley Fool contributor Dan Caplinger on Twitter @DanCaplinger. Motley Fool newsletter services have recommended Goldman Sachs.


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16 Comments

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commtranz

do we take advice from this big whale??? they just want to dupe consumers.... after they finish duping the super rich... they move onto furtile ground unsuspecting undereducated consumers who they out muscle....

February 08 2013 at 10:37 AM Report abuse rate up rate down Reply
n8sebay

Bonds follow intrest rates buy a bond at 5% intrest rate and it drops to 1% they still pay you 5% and it now has value. The reverse is true also buy a bond at 1% and the intrest rate jumps to 5% your still just getting your 1%
and have lost value. Stock is the reverse of bonds if the interest rate is low companies can borrow cheap expand and stock goes up. TIP! Buy bonds while rates are high Buy stock when rates are low.

February 07 2013 at 10:41 PM Report abuse rate up rate down Reply
tjstieg

Fire sale on Illinois bonds! Great S&P credit rating! Buy now!

February 07 2013 at 6:29 PM Report abuse rate up rate down Reply
suec8

The photo of US savings bonds in the article does not match the narrative for the corporate bonds in the article. I purchased US savings bonds when I was working in the 1980s and 1990s. They have been chugging along at 6% interest and will continue to do so for the entire 30 year maturity duration. Co-workers laughed at me when I purchased them stating they could get 10% interest on CDs at the time and the stock market was averaging almost 12%.
Since 2000 the stock market has performed poorly--my husband lost 50% of his retirement 401K savings during that period. CDs are getting 1-2% interest and corporate bonds are ready to collapse. So I think of my former co-workers and smile as my US savings bonds continue to grow at 6%. Now if you purchase them today, they are not nearly as good of a deal. Sometimes, slow and steady does win the race.

February 07 2013 at 6:23 PM Report abuse rate up rate down Reply
hsstempe

i prefer to spend mine my way instead of some sob of a beauracrat on what pork crap they want. give me MY
money and I will spend it when and on what notsome damn govt official paving the way to nowhere. Govt want to borrow MY money, GIVE ME A DECENT INTERST RATE and stop penalizing me for saving it. Ya wanna know why it's on the sidelines, cuz it's not making one red cent for ME instead of some BANK TO GOUGE ME OR MORTGAGE COMPANY OR WHATEVER.ON A CREDIT CARD OR FLOOD INSURANCE I TAX CUTS WORK! HEALTH CARE MY ASS. IT' CALLED SCREW THE GENERAL PUBLIC. FIRE EVERY DAMN ONE OF THOSE CROOKS! TERM LIMITS! NO BENEFITS. NO PERKS! REGULAR WAGES AND THEN SEE WHAT THEY THINK ABOUT PUBLIC NO SERVICE. REGAN GOT IT RIGHT! govt is the problem!

February 07 2013 at 6:23 PM Report abuse +1 rate up rate down Reply
AL CONFER

In World War ll The government created war bonds and contrary to the garbage heard on here, those war bonds paid for the war and then some and were extremely safe. America has fought two wars under George Bush and instead of raising taxes to support the war effort, taxes were cut, which by the way is insanity. Now the same old diatribe is being spoken again to continue to cut taxes, to supposedly create jobs, REALLY? The ultra rich were given tax break after tax break and were actually give tax writeoffs to create jobs and they did, in other countrys. Nice to know that the American taxpayers footed the bill to lose their own jobs to foreigners. By the way, I am a conservative that is totally fed up with both partys and be assured, I\'m not alone, these guys in Congress need to be booted out. It\'s all about them, their paychecks and retirement benefits that only they get.

February 07 2013 at 12:13 PM Report abuse +1 rate up rate down Reply
madddddddddddddd

MR OOOOOOOOOOOOOOOOOOOOOOOOOOOOOO R U LISTENING???????????????????????

February 07 2013 at 12:55 AM Report abuse +1 rate up rate down Reply
kentblackdog

Bond market has to crash--just a matter of when

Because of the goverment printing of lots and lots of money, when the resulting INFLATION hits, the bond market is going to crash, big time.

Can not keep printing money and monetizing the debt , and have the bond market make adjustments----like in crash

February 07 2013 at 12:36 AM Report abuse +2 rate up rate down Reply
the2431

Not much Demand.

Lots of Liquidity.

Global is still risky.

Low Rates not doing much to Spur Growth.

Bond Crash is Doubtful.................maybe a Balanced Budget, or just a Budget might help ?

GDP only Sputters...............No Growth !

February 06 2013 at 11:03 PM Report abuse -1 rate up rate down Reply
alstayl7

It is time to repudiate all of the debt of the US, including all entitlements and start over with a limit on the total taxation each state must bear as a percentage of the national GDP. We cannot repay our debts and our entitlements in real terms without causing a revolution by the young and healthy against the sick and the old. We currently "owe" 100 trillion dollars, the current value of everything in the US. The current policy of killing the dollar merely keeps the macabre dance going on a little longer. Friends don't let friends, relatives, or loved ones buy US bonds.

February 06 2013 at 4:59 PM Report abuse rate up rate down Reply