Over the weekend, several articles warned of the dangers of following the herd into bond funds. The most prominent was Sunday's New York Times, which wrote "For 'Safe' Investors, This May Be a Challenging Year. It said, "Money market funds are paying investors next to nothing. More precisely, the 100 biggest funds are now paying 0.05 percent annually, on average, a yield as low as it has ever been, according to Peter G. Crane, the president of Crane Data of Westborough, Mass."
The Times quoted Crane, "It's so low it's a joke. At that yield, it would take more than 1,000 years to double your money." The article continued, "This microscopic rate of return is part of the continuing fallout of the financial crisis -- a consequence of the very loose monetary policy of the Federal Reserve and other central banks."
The NYT piece wrote, "There are many indications that this herculean intervention has been working. In the bond market, though short-term interest rates are still hovering near zero, longer-term rates have been on an upward trajectory since late November. In part, this may be a healthy sign, suggesting that the economy is recovering. But it has also created a very unusual situation for financial markets, and it poses some tricky problems for savers, investors and home buyers."
The article continued, "William H. Gross, the co-chief investment officer of the Pacific Investment Management Company, or Pimco, the world's biggest bond manager, says the gap between short- and long-term rates has rarely been greater. Translated into the parlance of the bond market, the 'yield curve' has seldom been steeper."
But it said, "For investors, this can create some hard-to-resist temptations. People who have been holding cash in money market funds or in bank certificates of deposit, for example, may be yearning to buy longer-term bonds instead. Watch out, though. Liquidating investments that pay almost nothing in order to shift to long-term bonds that pay substantially more may not make sense right now, said Robert F. Auwaerter, the head of fixed-income investing at the Vanguard Group."
Finally, the Times wrote, "Still, many analysts project that the Fed will raise its benchmark Fed funds rate, bringing it to perhaps 1 percent by year-end.... For individuals focused on keeping their investments very safe, it's likely to be a challenging year." The piece quotes Crane, "Basically, savers are going to have to suck it up. Yields are so low that they're getting almost nothing in return, but this is not a time to play offense. Remember, if you're holding a money market fund or a C.D., you're there because you don't want to lose money. This is not the time to take a lot of risks."
See also, FT's "Fund chairman warns against following the herd on bonds" and SmartMoney's "The New Bond Bubble".
