Many investors are in for a rude awakening when they open their year-end retirement plan statements. The bond portion will probably show negative returns. It could even wipeout a good portion of their positive returns from owning equities.
Now, the most common method used in rebalancing your established asset allocation mix would be to reduce the holdings that are up in value (sell stocks) and buy assets that have fallen in price (buy bonds). This practice may have worked very well in the past but interest rates are going up forcing bond prices down.
The chart below compares the S&P 500 with the IShares 20 plus year Treasury bond ETF
“The decades-long bull market in U.S. Treasuries has finally drawn to a close following Donald Trump’s surprise presidential election victory, according to mutual-fund manager Bill Miller.”
“Miller isn’t the first to call time on the bond bull market. Economist Henry Kaufman, the original “Dr. Doom” who is credited with calling the last bond bear market in the 1970s, told the Financial Times this week that the current bull run is at an end.”
In the past, when the Federal Reserve decided it was time to unwind its easy monetary policies, it would raise the federal funds rate fairly quickly. The Fed believes a neutral stance on monetary policy is reached somewhere above the 4% level. The current Federal Reserve is moving slower than normal. Based on an average of three rate hikes per year, it will take the Fed a little over 4 years to normalize interest rates.
Tip # 1
Short-term, reduce or eliminate investing in target date mutual funds since they automatically rebalance from equities to bonds. Plus they increase your bond exposure the closer you are to retirement.
Tip # 2
During a period of rising interest rates, the prudent strategy is to reduce the duration of your bond portfolio. That could mean using a short-term bond ETF or a ladder of GICs both of which would allow you to benefit from an increase in rates.
Tip # 3
If you’re comfortable with a little credit risk, use short-term investment-grade corporate bonds to get a little more yield.
Tip # 4
Cash is by far the safest asset class. Move some of your equity allocation and some of your fixed income allocation to cash. I have my doubts that President Elect Trump can get congress to pass all his stimulus agenda and even economists are unsure if these policies will actual increase economic growth.
Corrections in the bond market are not as uncommon as you think. Most have been short in duration. See the chart below:
Keep in mind that in the past, rate hikes were implemented at a much faster pace than what the current Fed has purposed. Losses in the bond market could continue for longer than expected.