Don't Blame the Fed for Your Own Investment Mistakes
What's worse than making bad investment decisions? Making bad investment decisions and then blaming it on the Federal Reserve.
For almost a decade now, I've heard a variation of the same line: "Because of low interest rates, the Fed is forcing me to buy _____."
"The Fed Is Forcing Investors Back Into Stocks," writes Yahoo! Finance.
"The Fed Is Pushing Investors to Buy Junk Bonds," warns CNBC.
"Lower short-term rates have the effect of forcing investors to reach for income by lengthening the maturities of their portfolios and by taking on more risk," writes US News.
Low interest rates make it tempting to buy riskier assets, since that's where you can find respectable yields. But the Fed isn't forcing anyone to do anything. You can make (or decline) any investment you want, at any time, for any reason.
There's that classic mother-and-son scene where a mom is scolding her son for doing something bad. "But mom, Jimmy told me to do it!" the kid explains. "And if Jimmy told you to jump off a cliff, would you do that, too?" The mom asks.
"No, Mom, I'm not an idiot."
The relationship between you and the Fed is the same. You should never take risks you can't afford. It doesn't matter what the Fed is tempting you to do. If it's a bad deal, don't do it.
After the housing bubble burst, one of the standard lines of finger-pointing was that low interest rates forced investors to reach for yield, since they couldn't make enough money on Treasuries anymore. Back then, that meant buying subprime mortgage bonds. You know how the story ends -- many of the subprime bonds were soon worthless (Treasuries, ironically, have done extraordinarily well since).
The Fed made huge mistakes last decade. But no one was forced to reach for yield. No one was forced to buy subprime bonds.
Some would say, "But I needed yield. What choice did I have?" Well, how good did that extra percentage point of yield you earned in 2006 taste after your initial investment had gone up in flames by 2007?
It's similar today. With Treasuries yielding close to nothing and high-grade corporate bonds not far behind, investors have plowed into junk bonds with a passion. Junk bonds now yield what 3-month Treasuries yielded 12 years ago. In January, the market-weighted average junk bond traded at a 5% premium to par value, according to FridsonVision. With junk yields so low, it's nearing a lose-lose proposition, as the Financial Times pointed out: "If the economy deteriorates, the rising probability of default could cause spreads to widen. If the economy improves, yields would rise -- and prices fall -- for all manner of fixed-income securities."
The usual response from investors participating in this insanity is that junk bonds are the only place you can find yield these days. But if you think earning low yields in safe investments is bad, wait until the air comes out of the junk bond market and you lose a big chunk of your principal. It'll hurt a lot worse.
I think what this comes down to is short-term thinking. Being hungry for yield and running into junk bonds might make sense if you're only thinking about the next few months or the next year ahead. But if your investment time frame extends any longer, the odds increase that you are taking risks that far outweigh the rewards. Get a little bit extra yield today, pay a big price tomorrow.
When the tide turns, don't blame the Fed. Blame yourself.
Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.
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