Are Bonds a safe investment?
We have seen our fair share of hurricanes and tropical storms during 2020. As of this writing, tropical storm Beta is churning in the gulf with its site on the Texas coastlines. Remember, you can do everything right. You can have the hurricane rated storm windows in your house, your home elevated to just the right height, and do everything humanly possible to protect your house from the wind and the rain and still suffer damage.
It is the same with your 401 K plan. You can take your money and move 100% to bond funds (the "safer" of the two alternatives-DISCLAIMER below) and still lose money.
There is no 100% solution to protect yourself from a hurricane, just like there is no 100% way to protect yourself from losing money in a 401 K plan. No investing strategy eliminates risk. All we can do is increase or decrease risk. Think of a light dimmer as used in yesterdays post (read here)
Bond Funds can lose money. Some types of bond funds, such as high yield or junk bonds, can lose as much as stocks. General bond funds are not safe - they are historically safer than stock funds. Having said that, past performance is not predictive of future performance.
I needed to get that out of the way. I still think that bond funds play a role in managing against risks and losses in your 401 K plan. Let me go ahead and say without question; I think that high yield and junk bond funds are not good options. They are bonds that are used by companies who have risky debt situations. Said another way, you might invest your money in the bonds of these companies and never see your money again.
Historically speaking, a small percentage of the time, bonds and stocks have both lost money in a given year. Since that percentage, if so small, bonds have been a suitable type of investment in uncertain times. There is one thing you need to know about bond funds, and that is interest rates.
When interest rates DECREASE, prices of bonds INCREASE. When interest rates INCREASE, prices of bonds DECREASE. This is important to know because interest rates have been FALLING, and bond prices have been INCREASING. Interest rates started falling since the early '80s. Today they are right around historic record lows. Thus at some point, interest rates will start INCREASING, thus harming bond prices. When that will happen is anyone's guess. At the end of the day, what am I trying to say is that bonds can lose money. It is important to be aware of that fact. There is a good percentage of people who don't think that can happen.
So, that is the Back to the Basics lesson. To determine which bond funds you should use, ask your financial adviser or send me your choices (ask bob) or ask your 401 K plan provider these questions:
What short-duration bond funds are available to me?
DO I have a stable value fund?
Are there any highly rated corporate bond funds available?
These questions are the ones you should be asking so that you can hopefully put together a prudent portfolio of bonds to offset the risk in your 401 K plan.