Investors have been flocking to bond mutual funds at record levels the last several months. Those tired of zero- return cash are pulling money from money market funds and reaching for yield by piling into other options such as bond funds. Other investors, still smarting from the financial crisis and weary of our current economic malaise, are abandoning stocks and moving their money into the perceived safety of bonds. 2008, 2009 and now year to date 2010 have all seen net outflows from U.S. Stock funds.1 This behavior is highly predictable. After all, human nature has not been repealed—stocks have been extremely lousy performers the last three years and bonds have done well recently. Going forward, however, investors need to be aware of the risks that exist in bonds right now and the potential opportunity stocks can offer to long term investors.
With interest rates at all time lows, they have nowhere to go but up. Bonds generally perform poorly in a rising interest rate environment. When rates go up bond prices go down. Our sluggish recovery will hold rates low for some time, but sooner or later rates will rise. Most everyone agrees that this is not a question of if but when. A better alternative going forward may be high quality dividend paying stocks. In fact, for the first time in more than 50 years, a large number of stocks have dividend yields that are higher than comparable corporate bond yields.2 This is just one example of why stocks may be cheap, relative to bonds.
Mutual fund flows can be a fairly reliable contrarian indicator of which asset classes will do well and which will do poorly over the next chunk of time. Show me an asset class that is experiencing record inflows, like bonds now (perhaps gold as well?), and I will show you an asset class that will probably underperform over the next block of time. Show me an asset class that the general public is fleeing, like stocks the last three years, and I will show you an asset class poised to be the next outperformer. History does not repeat itself, but it does rhyme.
Don’t get me wrong, bonds can be a very important part of one’s portfolio. My concern is more for those that have come to the bond party more recently and may not adequately appreciate what could go wrong. When rates move up, certain types of bonds can do better than others so be sure to understand what you own. Lastly, don’t give up on stocks. Patience will be required but could prove profitable in the long run.
- Business Insider, Investor Fund Flows Have Never Been This Bearish Since Lehman Collapsed, June 6, 2010
- Wellington Management, Do Dividends Matter, July 2010
Damien helps individuals invest and manage risk. He is a CERTIFIED FINANCIAL PLANNER™ professional and a principal of Walnut Creek Wealth Management. These are the views of Damien Couture, CFP® and should not be construed as investment advice. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. Investors should consider the investment objectives, risks and charges and expenses of the funds carefully before investing. The prospectus contains this and other information about the funds. Contact Damien Couture at 1850 Mt. Diablo Blvd., Ste. 170 Walnut Creek, CA 94596, 925-280-1800, walnutcreekwealth.com to obtain a prospectus, which should be read carefully before investing or sending money. Your comments are welcome. Damien can be reached at 925-280-1800 x101 or Damien@WalnutCreekWealth.com.