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How to Avoid Getting Burned by Bonds

How to Avoid Getting Burned by Bonds

In financial circles, it is well established that there is really only one reason why investors would chose to put their money in U.S. Treasury bonds: Safety. You put your cash in and you're guaranteed by the full faith and credit of the U.S. government to get it all back. That's assuming you plan to hold your bonds until maturity, be that for three months or 30 years.

"In this environment, when rates pop back up, you're going to see huge swings down in long-term bonds, and even short term bonds, and some investors don't understand that," says Ted Parrish, director of investments at Henssler Financial, in the attached video.

For example, a risk-free investor who rolled over a $100,000 certificate of deposit into 10-year Treasuries a month ago, would be holding debt that is only worth about $91,000 today. Further worsening this bond burn is the fact that yield-starved investors have been driven to do all sorts of things in search of a decent return.

"Interest rates have been so low that it has pushed investors to reach a little further down the credit ladder and also further out on maturities to get some yield," Parrish says. In addition, he says professionally managed portfolios, or bond funds, pose "a huge risk for investors."

"I hate to throw bond fund investors under the bus, but when you own a bond fund you don't know exactly what that bond fund manager is buying," he says.

As much as some bond heavyweights, including PIMCO's Bill Gross, have predicted a comeback in demand for the 10-year will drive its yield below two percent again by year-end, Parrish respectfully disagrees.

"That could very well happen if the rest of the world falls apart," Parrish says. "But I think if the U.S. economy continues to grow, the Fed is probably going to come through with its promise and actually stop buying bonds, that is definitely going to put pressure on rates."

Bill Gross is "a very smart guy," says Parrish. "I wouldn't directly bet against him, and come on Yahoo! Finance and says he's wrong, but we're putting our money against the bond market right now and are waiting for higher rates."

Whoever ends up being right on rates, it's clear that investors need to be on guard before dabbling in a bond market that's on the move.