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Bond bubble?No problemif you stickwith a plan

Sunday, July 7, 2013

It's not easy knowing what to do with investments these days, even when you're in the information business.

Ever since the housing bubble burst in 2007, many people ran to safety in bond or money market mutual funds, or even just put cash in a savings account.

They paid very little but the gurus said they were the safe place to be. As in pennies on the dollar are better than losing the dollar.

Now it turns out the U.S. economy is doing so well that the Fed probably is going to start buying fewer of its own bonds. This means interest rates are going to go up and some people are warning us about the places the experts said were safe -- such as bond funds.

These were supposed to be the stodgy but solid earners, that paid you dividends every month.

The wise approach supposedly was to tuck away from every paycheck as much as you could in your 401(k) or other retirement plan, and have it buy shares in various funds. When you are younger you do this mostly in stock funds but also some bond funds. This is to diversify, so you don't have all your eggs in one basket.

Then gradually you shift this emphasis toward more bonds as you get closer to retirement.

That way you don't have as much money at risk from the volatile whims of the stock market, or the housing market, or the next speculative frenzy.

You also were doing something with a fancy name: “dollar cost averaging.” This means buying more shares of the funds you allocated for your retirement dollars when they cost less. (Or buying fewer shares when they cost more.)

It's a way of not over thinking your investments and taking advantage of market dips, say the experts. It's also a way of avoiding what seems like fun but many warn against -- the dreaded game of market timing.

I can grasp this. But if you've ever tried to wrap your mind around bonds it gets a bit trickier.

This is because bonds pay regular dividends, which you should have reinvested buying more shares for you each month. This can be very sweet when you own shares in a bond fund that works like it should, which is maintaining a share price that does not fluctuate much.

Every month it pays you dividends, which you turn around and buy more shares with on top of the shares you are buying with your regular paycheck retirement withdrawals. More shares paying you more, buying more shares that pay you even more, and on and on until one day you will be a multi-millionaire and able to live off your dividends like Mitt Romney.

Isn't capitalism grand?

Now, unbeknownst to most of us, the prices of many types of bonds have been inflated. Maybe because so many people wanted them.

Experts warn the value for many is dropping and could keep going. Some steeply as rising interest rates cause investors to look elsewhere for even better returns.

At first you may think this would be just fine. Since the dividend usually moves opposite to the price, you'll be paid more to buy more shares at a cheaper price.

But some experts now warn bond prices could be so overheated they won't compensate for what's lost in value we already own.

In other words we could see a serious drop in our investment values and not recover for some time. Kind of like the stock decline following the most recent recession. I thought this is why we fled to bonds in the first place?

Yes, it's tough to know what to do. As always it's good to turn to advice from people who know a lot about such things.

Earlier this year, Steve Ciccone, associate professor of finance at UNH, reinforced his belief in the power of dollar cost averaging combined with faith that the stock market is the best bet over the long haul.

Even if you are ready to retire, having almost a third of your investments in stocks is the way to go for their potential to increase in value, he said. So while many of us thought we were being responsible by fleeing to safer investments, we actually should have stayed with our allocation plan for more stocks versus bonds based on our age.

Plus, if we fled to safety we missed out on a very good stock market the last year. Shame on us if we got scared and reallocated.

It isn't too late to get back on track, however.

Patricia Ouimet, a financial advisor formerly from Portsmouth, wrote an occasional column for us on money matters. She was big on planning and diversification of assets and thinking longer term.

She reminded us that even if you stop working at 65 you likely are looking at 20 to 25 more years of living off your investments. There are all sorts of places to park those funds, but mixing it up is key to avoiding scary declines. Diversifying and sticking with your plan means you can sleep at night.

So the bottom line is the bond bubble should be just another blimp in our financial timeline, not something to worry about. If you're saving what you should, it just means you'll buy more shares and be able to ride out price declines over time. You'll actually be better off if you don't even understand it.

Stick with a plan. Tweak your allocations based on age not markets. Don't bet big on any one thing. But don't fear the stock market. And in most cases, do nothing because the economy is just fine and taking us along with it.

Jeremiah Turner can be reached at