Most investors look at bonds as being the safe part of their portfolio. But many of them got a nasty surprise when they opened their quarterly brokerage statements last month, only to find that while the stock market continued to perform well, the bonds they relied on for stability and security betrayed them with considerable losses.
Interest rates have risen dramatically in recent months, as investors begin to anticipate that the Federal Reserve will ease off on the extraordinary measures it has taken to stimulate economic activity. Because of the way bond prices work, those rising rates have hurt the value of existing bonds, producing major losses for unsuspecting investors.
How Bad Did Bonds Do?
Bond losses have been widespread and significant. General-purpose bond funds like Vanguard Total Bond Market ETF (BND) and Pimco Total Return ETF (BOND) have given up 4 percent to 5 percent of their value since the beginning of May, while investment vehicles that focus on longer-term bonds, such as the iShares Barclays 20+ Year Treasury Bond ETF (TLT), have posted double-digit percentage drops. Even the inflation-adjusted iShares TIPS Bond (TIP) ETF -- which many turned to as a way of avoiding potential bond-market volatility -- has dropped almost 8 percent since the end of April, even as inflation remains largely under control.
Many people have moved their bond money into the stock market and other alternative investments. With high dividend yields, you can get more income from those investments than bonds pay right now. But they also come with considerable risk of loss.
With the goal of safety and security in mind, let's look at some bond alternatives that won't make you lose your shirt.
1. Bank CDs.
Certificates of deposit look almost exactly like bonds, in that you make an upfront deposit in exchange for the promise of your money back after a certain time and interest payments along the way. But unlike bonds, you usually have the right to withdraw your money from a CD early, paying only an interest penalty rather than any decline in the market value of a bond.
In fact, some banks pay slightly better yields on their CDs than comparable government bonds of the same duration, even though both are guaranteed by the full faith and credit of the U.S. Treasury. With price protection and better income, bank CDs are a no-brainer compared to Treasury bonds right now for most individual investors.
2. Savings Accounts.
Bank savings accounts carry the same federal deposit insurance that CDs do. The difference, of course, is that with savings accounts, you don't have to lock up your money for a set period of time.
Of course, the price of that flexibility is a lower rate, with many well-known banks paying almost no interest at all. But if you do your shopping and are open to using online banking, you can find savings accounts that pay as much as 1 percent -- comparable to the rates you'll find on many CDs that force you to tie up your money for a year or two. Having the money liquid will let you jump on higher-rate opportunities as they arise.
3. Savings Bonds.
Savings bonds are an easy way to put money to work safely, as they too are obligations of the U.S. government. They come in two types: series I bonds and series EE bonds.
I-bonds have interest rates that are linked to the current rate of inflation, with new I-bonds paying 1.18 percent during their first six months. After that, the rate will change to match whatever the increase in the consumer price index was over the preceding six-month measuring period.
EE-bonds, on the other hand, only pay 0.2 percent, making them a poor short-term alternative. But if you hold EE-bonds for 20 years, you're guaranteed to double your money -- which equates to an average 3.5 percent annual interest rate.
Savings bonds require a minimum one-year holding period, and if they're less than five years old when you redeem them, you'll pay a penalty of three months of interest. But with investment amounts as little as $25, the flexibility that savings bonds give appeals to many savers.
With bonds producing big losses for unsuspecting investors, take a look at these bond alternatives. They won't necessarily give you a huge amount of income right now, but they'll prevent the losses that you've seen in your regular bond holdings -- and could continue to see for the foreseeable future.
3 Safe Bond Alternatives to Protect Your Portfolio
From taxes and credit to saving and money management, you can get lost in the complexity and abundance of financial issues. But by learning some simple fundamentals, you can take control of your finances and feel secure in your money management skills.
How well do you know the basics of personal finance?
Put your knowledge to the test with this 12-question quiz.
A. Under your mattress
D. Bank savings account
You want money you plan to use within the next three to five years to be safe and easily accessible. Lock it up in a savings or money market account. You won't earn much interest on it with rates so low, but you also won't lose any of it to the volatility of the stock market. You can find search for which accounts are offering the best rates on Bankrate.com.
A. Suck up to the boss
B. Get a second job
C. Adjust your tax withholding
If you typically get a tax refund each spring (and most of you do), file a new Form W-4 with your employer to increase the number of exemptions you claim - and lower the amount Uncle Sam takes from your paycheck. Try our easy-to-use tax withholding calculator to help you figure the right number for your situation.
A. Pay bills on time and keep credit-card balances low
B. Limit applications for new credit and keep old accounts open
C. Sweet-talk the credit-card company phone rep
The simple act of paying bills on time and keeping your balances low accounts for 65% of your credit score. New credit and the length of your credit history make up 25% of your score. The remaining 10% factors in the types of credit you use. Sorry, sweet-talking will get you nowhere.
A. Treasury bonds
B. Money market account
D. Residential real estate
Stocks fare best over long stretches of time. Take the 20-year period through 2012, for example. The average taxable U.S. money-market fund returned 2.8% annualized. Residential real estate, as measured by Standard & Poor's Case-Shiller index, did just slightly better with 3.0% annualized. Barclay's U.S. Treasury index earned 6.3% a year, on average. And the S&P 500 trumped them all, delivering 8.2% annualized.
A. Life insurance
B. Health insurance
C. Auto insurance
You only need life insurance if you have someone depending on you financially. Bob is unwed and childless, so he doesn't need it. However, he will need health insurance and auto insurance to protect himself against disaster.
B. 529 plan
C. Municipal bonds
D. Certificate of deposit
E. None of the above
A bank CD falls under federal protection if it's FDIC insured. That means up to $250,000 is protected in case a bank goes under, and you get up to $250,000 of insurance at each bank where you buy CDs. Municipal bonds, 529 plans, 401(k)s and other investments are not covered. You invest at your own risk.
Ashley, age 20, contributes $3,000 per year to an individual retirement account for ten years, then stops, letting her money sit in the account. Adam, age 30, contributes $3,000 each year to an IRA for 35 years. Who will have more money at age 65, assuming they get identical investment returns?
Ashley comes out ahead, thanks to the magic of compounding. Even though she stopped contributing after only ten years, her money will grow to about $694,000 by the time she retires, assuming an 8% annual return. Adam, who got a late start, but pitched in more money out of pocket, will amass about $558,000.
A. Your credit score
B. Your car make and model
C. Your car color
D. Your address
Insurers look at a variety of factors to calculate your risk, but the color of your car isn't one of them. Your financial habits, the type of car you drive and where you drive do matter.
A. At age 16
B. At age 18
C. When they get their first job
D. When their income reaches certain levels
A child's age or job has nothing to do with it. Rather, the IRS cares about how much the child made and the source of the income. For example, children who have investment income of more than $950 or have wage income of more than $5,950 in 2012 need to file a return. Children who receive a paycheck and have taxes withheld may want to file even if they don't have to - they could reclaim most or all of their income taxes.
You can withdraw contributions you made to a Roth IRA at any time, for any purpose without paying any taxes or penalties, and without having to pay it back - ever.
Any money you put into your Roth IRA is yours for the taking - even if you aren't retired. The money your account earns, however, cannot be touched until you're 59½ and have had a Roth for at least five years. Otherwise, you'll owe taxes and a 10% early withdrawal penalty on earnings. An exception: Once the money's been in your account for five years, you can tap your earnings to buy your first home.
B. Notify your bank and credit-card companies
C. Contact the credit bureaus
D. Call the Social Security office
Put your tears of frustration on hold. First, notify your credit-card companies and bank to monitor your accounts for fraudulent charges, just in case your wallet falls into the wrong hands. Second, contact the credit bureaus and put a fraud alert on your report. This will require lenders to make an effort to verify your identity before issuing new credit in your name. It also gives you a free copy of your credit report so you can review it for suspicious activity.
A. Upgrade your lifestyle: You've been pinching pennies for too long. It's time to reward yourself and live it up.
B. Maintain your lifestyle: Take this opportunity to pay off your high-interest debts and boost your savings. It's time to get ahead.
Sure, it's tempting to spend the money, but using it to strengthen your financial footing is the smarter choice that'll pay off exponentially in the long run.