Investors Misguided About Bond Risk
By TIM COLWELL
Contributing Writer
SIDNEY SHUPACK
Are bonds the safe and secure way to invest? One Tulsa money manager says many investors are making a mistake in assuming bonds are risk free.
Sid Shupack, founder and president of First State Investment Advisors, said that in this environment, many Tulsans may be making a mistake buying bonds, hoping they are minimizing risk.
“We’ve talked with investors who found out differently,” he states.
This month the U.S. Treasury Department announced it would begin selling 30-year bonds next year, the first time these bonds have been offered since 2001. For some, the offering may be the right investment, but for others it can be economically disastrous, says Shupack.
“What would happen if for some unforeseen reason you needed cash before the end of the bond term?” he asks. Selling prematurely may require a discount, which greatly impacts their investment.
“To maximize credit quality it’s best to stay in AAA-rated bonds,” the money manager states. But long-term bonds historically have significant fluctuations due to changes in interest rates. Lock-in to the current low rates and if rates go up, the investor is stuck. Increased rates decrease bond values because investors can get a higher return with a new issue.
“Interest rates have stayed at unusually low levels for the past several years,” Shupack observes. “Federal fund rates have risen just two percent over the past two years. At what point will rates increase? Are we past due?” he asks.
Consider this: The price of a five percent 30-year government bond drops to $71.50 from $100 if the current rate increases from five to seven percent.
Shupack offeres this measurement guide: The 10-year bond rate should reflect the inflation rate (now 2.5 percent), plus “rent” for your investment funds (2.5 percent), plus some premium for your taking a risk (.25 percent). That should equate to 5.25 percent annual growth. Bond rates are now around 3.5 percent. “There may be better ways to invest your funds and not be penalized,” he says.
So what is an investor who needs security, but also possible liquidity in a few years, to do? In six months, rates should be higher, says Shupack. Therefore, buy one- to two-year U.S. Government Agencies or certificates of deposit. “It is prudent to wait for this change in rates.”
Sid Shupack can be reached at First State Investment Advisors, a professional money management firm that manages more than $55 million in fee-based assets. The telephone number Is (918) 492-1466, and the firm’s website is www.firststate-ok.com.
Updated 08-19-2005
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