Bond Investing

SHOULD YOU EVEN BOTHER OWNING GOVERNMENT BONDS?

Jeremy Siegel (along with other academics) Says NO!

1. Understanding the relationship between Bond Values and Interest Rates

Picture a teeter-totter. On one side, you have bond values. On the other side, you have interest rates. When interest rates rise, bond values fall. And when interest rates fall, bond values rise. This is the basic relationship between bond values and interest rates. They move "inversely" meaning that they move in opposite directions. Interest rates drive bond values.

2. A little History....Now, let's think back 30 years or so. what were interest rates int he late 1970's/early 80's? They were very high. In fact they peaked over 15% for a 10 year government bond in 1981. What are interest rates today for that same bond...just over 3%.

The last 30 years have represented the garden of Eden for the bond market. You had 30 years of decreasing interest rates.

3. What will happen (not what might)

Interest rates have bottomed out, they are as low as they can go(the Fed Fund rate is almost 0%). What does this mean for bonds? It means that interest rates can only increase or stay the same. The best case scenario (for bond values) is that interest rates stay the same. If so, you will collect just over 3%.

But what happens if interest rates start rising? They will when inflation starts to show its ugly head or no one shows up to buy Treasuries. That happened last week. What happens? That's right--the opposite side of the teeter-totter will go down...the value of current bond prices. It's won't be pretty!