Money & Finance

Christopher Van Slyke has an unusual dilemma for a financial planner: He won’t sell the investment many of his prospective customers now want to buy. About a year ago, he started getting a stream of potential clients coming into his Los Angeles office wanting “risk-free” portfolios stuffed with bonds.

He’s not opposed to bonds, but in recent months he has taken a dim view of a once dull but steady investment. Yet the requests keep coming. For municipal bonds. For corporate bonds. For bond funds. And Van Slyke has kept saying no, even after a local branch of the broker TD Ameritrade stopped recommending customers to him.

“I’m not going to let you hire me to build a bad portfolio,” Van Slyke said.

In the late 1990s, it was tech stocks. In the mid-2000s, it was real estate. And today bonds are the investment people can’t get enough of, unlikely as that might seem. Lured by bonds’ perceived safety — not to mention some spectacular deals, the kind unseen in decades, with 15% yields — investors plowed $313 billion more into bond funds than they took out in the first 10 months of 2009.

That’s a staggering amount considering that over the same time investors withdrew about as much money as they put into stock funds. But in a remarkably short period, a lot of those fantastic bond deals have faded, with a good many bonds now yielding half of what they did last summer.

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And though a return on a corporate, municipal or Treasury bond might look better compared with that of a bank account — then again, what doesn’t? — many bonds are carrying a lot more risk. When some investing pros look at the bond market and the frenzied demand for fixed income, they do not like what they see.

“It has a bubble look to it,” says Thomas Atteberry, the manager of FPA New Income, one of the largest independent bond funds.

Not all investing pros see it this way, of course, and most continue to advise that some bonds should be included in investor portfolios. Still, some experts in the bond world have started to worry that if a bubble were to burst, it wouldn’t be too far off.

What a bust would look like

A bond bust might not be as obvious to ordinary investors as a stock crash. There likely wouldn’t be the dot-com-style flameouts we saw in 2000.

But when they happen, bond debacles can have an insidious effect on people’s nest eggs. If interest rates were to rise, for example — and many analysts believe that’s likely — bond prices could get clobbered. Prices on even “safe” Treasury and municipal bonds could fall 30% or more if interest rates soared over the next few years. Some corporate bonds could fall even more.

The basics of bond investing

“Even with government funds, people forget you can lose money,” says Carol Clark, an investment principal at Lowry Hill, a money management firm in Minneapolis.

To be sure, if a bond’s price falls, instead of selling the bond at a loss, the investor could just sit and collect the interest it pays. That wouldn’t be a stretch for most people, as an overwhelming majority of individual investors hold their bonds until maturity, according to BondDesk Group, a fixed-income broker. But doing that means holding a bond for years, perhaps decades.

The 4.7% annual interest that a current 20-year Treasury bond is paying might look good now compared with a bank certificate of deposit, but it will seem mediocre in five years if interest rates rise and banks start offering 7% CDs — while you’re stuck until the bond matures in 2030.

Bond mutual fund owners don’t even have a say in whether to hold their bonds. Their funds can lose money, and in late 2008, when the credit markets froze, the average bond fund lost 12%, according to Morningstar. Individual investors, however, keep jumping into the bond pool. As late as October, when most of the best bond deals were long gone, investors were calling up their brokers to get in on the bond craze. In fact, that month they bought nearly $88 billion in bond funds, or about $118 million an hour.

That includes people like Hemang Shah, a Virginia Beach, Va., neurologist who sees bonds as a way to get to retirement safely. By his own admission, bonds aren’t as attractive as they once were and carry new risk. But he recently told his financial planner to increase his bond holdings by 50% because, he says, he’s unable to shake the memory of losing so much of his savings — first to the 2000 tech bubble, then to the real-estate bust and then, most recently, to the market crash.

“It was money I earned day by day, working my butt off, that I lost,” Shah says.

Risk-free? Not really

Bonds, of course, are not the most straightforward of investments. Trying to explain how bond prices work — they usually go down when interest rates go up, and vice versa — can exhaust even patient financial planners. Looking up an individual bond’s price can be excruciating, often requiring you to remember not only the bond’s exact name but also its nine-character identification.

Nevertheless, many investors still have one thing in mind when it comes to bonds, something drilled into many people at an early age when they received a U.S. savings bond as their first investment: Bonds are predictable and a lot less risky than stocks.

That attitude could now come back to bite people. “Investors in bonds don’t expect risk, and the longer the Federal Reserve keeps rates low, the more complacent people become,” says Lawrence Glazer, managing partner of Mayflower Advisors, a money-management company.

 

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