Yahoo Finance What Danger Exists in Your Long-Term Investments? Here’s What Experts Have To Say
The financial markets changed dramatically over the last two years — with one glaring exception. Long-term bond yields are still behaving as they were when interest rates were near zero and inflation was low. If and when they catch up with the times, the ripple effects could impact your investments whether you buy government debt or not.
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Are Term Premiums Flashing a Warning Sign?
According to the Wall Street Journal, bonds cushioned stock selloffs during the era of low interest rates and volatility that defined the last decade. While those conditions have reversed over the last couple of years, the so-called term premium — the return the Federal Reserve thinks is sufficient for investors to buy 10-year government bonds — is frozen in time. Yields remain low even though rising inflation and interest rates have climbed to the point where most investors could do better with a money market account.
If the anomaly were to self-correct and term premiums returned to their historical average, 10-year Treasury yields would jump to 6.1%, making risk-free government paper a highly enticing place for investors to park their cash — and that could have dire consequences for your 401(k).
“A decrease in bond prices due to higher yields can lead to a stock market selloff as bonds become more attractive to investors,” said Laura Adams, MBA, an award-winning personal finance author and expert with Finder.com. “If investors move their money from equities to bonds, it can put downward pressure on stock prices.”
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The Bond Market Oddity Is Just One Cause for Concern
Out-of-balance term premiums are only one variable of several that worry Baruch Silvermann, CEO of The Smart Investor.
“Unfortunately, I believe we should be concerned about the next six months,” he said, citing the ongoing threat of a recession, the banking sector’s perceived instability and a weakening job market.
“Additionally, the yields on government bonds are increasing, but not as much as expected, indicating high demand from investors who are worried about the future,” said Silvermann.
He also thinks there’s a historical precedent for the lag in term premiums catching up to rising interest rates.
“The full ramifications of these new rates typically take approximately nine to 18 months to manifest in the economy, implying that we are yet to witness their complete impact,” he said.
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According to the WSJ, the Fed’s term premium calculations usually track the Treasury yield curve, which has been inverted for a year but is steepening again, indicating that higher yields are on the horizon. This is especially important considering government bonds serve as a benchmark for the debt of blue-chip companies, which the WSJ says is “undermining an argument for buying stocks at today’s prices.”
Fed term premium calculations are imperfect, but yields are undoubtedly out of balance with interest rates. Stock investors shouldn’t panic, but they should take notice.
“Investors should definitely be attentive,” said personal finance advisor and senior Wallet Savvy writer Michael Barton, who formerly held executive positions at Merrill Lynch, Cargill Investor Services and Goldman Sachs. “I remember, back at one of my previous companies, we had a similar situation where market trends outpaced yield adjustments. One of my top clients was concerned about her substantial bond investments. I advised her to diversify her portfolio, and thankfully, she heeded that advice. Later on, when yields did catch up, her diversified investments cushioned the blow.”
If you have money in the stock market, now might be the time to follow the lead of Barton’s client.
Don’t Panic Sell, but Prepare Your Portfolio for the Worst
The WSJ outlined several fairly benign scenarios that could account for the term premium’s bizarre behavior — and Barton agrees.
“Some argue that market dynamics are just more complex now and that the old relationships between bonds and stocks aren’t as straightforward as they once were,” he said. “They believe that while there’s potential for adjustment, the markets might absorb the changes without a major selloff.”
Even so, now is the time to revisit your holdings.
“Diversifying is crucial,” said Barton. “Investing heavily in one area, be it stocks or bonds, can make you vulnerable. Not all investors think of bonds as volatile, but as market dynamics shift, so can the perceived safety of these instruments. That being said, a massive stock selloff due to rising yields isn’t a certainty but a possibility.”
Silvermann concurs.
“In my opinion, it’s better to play it safe now,” he said. “The risks are too high and the stock market chart looks too much like it did in 2008. You can consider safer investments like savings accounts, CDs, government bonds or high-rate corporate bonds. These options can offer a decent annual return of 4%-6%.”
But you should aim for stable, balanced holdings that can withstand unpredictable markets irrespective of term premiums or any other variable.
“Regardless of market movements, a diversified portfolio is a cornerstone of sound investing for most consumers,” said Adams. “Even if stock prices drop, they benefit a broader portfolio even during downturns. It may be an opportunity to rebalance your portfolio to reach a desired allocation for stocks and bonds based on your risk tolerance and financial goals.”
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