Why Should You Not Assume Bond Investments Are “Conservative” Investments That Will Always Create “Fixed Income” Returns?

Why did I start my first post with a discussion on bonds?

I tend to write about what may be of greater importance now.  I’m writing about bonds because understanding bonds is currently very important, heading into both the near term and long term investment windows.

Bonds are an important topic for the millions of people with retirement savings invested in “fixed income,” “balanced” (part bond/part stock), or other investments that are heavily invested in bond or bond-like investments.

For example, like many parents, I have children with college savings programs.  Why would a bond discussion be important for a parent saving money for their 6 or 16 year old kid’s college savings? It is important because most college savings programs allow an investor to invest in stocks, bonds, or a low-interest fixed-return savings.

These savings programs often have significant limitations on how many times each year an investor may re-allocate their investments. In some programs, like mine, you can only change your allocations once a year.

Heading into 2013, I suspected bonds may be headed for a downturn in gains. So, in early January, I immediately dramatically reduced my childrens’ allocation in bonds and increased their allocation in stocks. My strategy is attempting to be conservative, attempting to preserve principal by making those two allocation percentages less disparate, so the gains of one might offset losses of the other.

If a parent, trying to be conservative with their childrens’ savings, didn’t know better, and simply followed the different investment descriptions, a parent might think a “Conservative Allocation” (an allocation that is mostly in bonds) would be the allocation most likely to avoid losing principal in any given year.

But bonds lost money in January 2013, and there is a slim chance they may lose money for all of 2013. Because bonds can lose value, bonds should not always be labeled as a “conservative” option. Further, because bonds can lose more value in principal than they earn in interest, they also cannot be expected to create a “fixed income” in some years.

Specifically, so far in 2013, between Jan 1 and Feb 1, bonds lost an average of almost -1.2% in value.  Almost all US-based bond funds lost value in January 2013.  If bonds continue to lose that much value over the next eleven months (not compounding, but simply losing the same amount), bonds will lose principal value of about -14.4%.  So, if their average interest return is only 2.75% APY, an investor could lose over -11% in principal in one year. That is neither “conservative” nor “fixed income.”  That is also an unlikely outcome for all of 2013 because the Fed is doing everything (and then some) to try to keep the bond market stable.

I’m not predicting bonds will lose that much value in 2013. Bonds could lose more or less than that amount.  They could gain value.  My point is, bonds may not be a “conservative” choice to create an reasonable expectation of a “fixed income” source for 2013.  This is true whether you’re saving for your grandchildren’s education or your retirement.

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Disclaimer:  These posts are not written by a professional or licensed financial advisor.  There’s nothing for sale here.  This is just a discussion forum.  No one should make any decisions based on representations made on this informal blog.  These posts are just one layperson’s opinions, concerns, and observations about asset classes – a part of larger, never-ending discussions.  Any significant financial decisions should be discussed with at least a few trusted and experienced financial advisors before acting.

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