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WARNING: When the Fed raises rates, your bonds could lose 25% – Do not own bonds. Sell. Move out now. – PAUL B. FARRELL


10 investing rules for the coming bond crash

By Paul B. Farrell, MarketWatch

 

“The best piece of advice I could give long-term investors today is don’t own bonds. And if you do own them, you probably ought to move out of them,” warns Charles Ellis, acclaimed author of the classic “Winning the Loser’s Game: Timeless Strategies for Successful Investing.”

Get it? Do not own bonds. Sell. Move out now.

Sound familiar? You bet. Ellis’ warning came during a CNN/Money interview with Penelope Wang, just one month after the cover of InvestmentNews was screaming the same warning in huge bold type: “Tick, Tick … Boom!”

In that “special report on the impending crisis in the bond market,” InvestmentNews the newspaper of record for 90,000 professional advisers, I-News was predicting a “bond bomb” will explode, asking rhetorically: “What will your clients’ portfolios look like when the bond bomb goes off?” Answer: Bonds will crash, with huge loses.

When the Fed raises rates, your bonds could lose 25%

Here are the numbers: “Right now the Federal Reserve is set on keeping rates down,” explains Ellis, because “the yield on a 10-year Treasury bond is under 2%. When yields go back to their historical average of 5.5%, an intermediate bond fund could go down 25% in value.”

Remember that warning when Bernanke and the Fed signal the next rate increase, because it is coming. And sooner than you think. But unfortunately, Wall Street insiders, 90,000 advisers and America’s 95 million Main Street investors with trillions in retirement accounts are in denial of that highly likely event … why else are the warnings getting so loud?

What happens after the crash? Investors will get hit hard: Ellis says “people who are putting their retirement money into [so-called] safe-bonds can get hurt badly,” echoing I-News warning “when the bond bomb goes off.”

Forget individual stocks, buy index funds

Wang then asked: “So they should be buying stocks?” Ellis was emphatic: Not stocks. “They should absolutely invest in a low-cost index fund … forget about stock-picking.”

Why no individual stocks? Very simple: The fact is that most investment advisers are losers. Or as Ellis more delicately puts it: “Most active managers underperform because of the fees.” In fact, 80% of all investment advisers lose money for their clients because “after fees, their returns end up being below the market.”

Yes, they are losers. They are losing their investors’ hard-earned retirement money. Solution: Investors should switch to index funds to save 30%. But year after year they remain in denial and just keep throwing away their hard-earned retirement money.

Most financial news is misleading. Why? Because it helps market insiders, the pros with itchy fingers who love short-term trading. They’re different from you and me. They spend all day tracking the markets with their sophisticated algorithms that think in milliseconds.

In time, most of them get it wrong: How else can you explain why in the first decade of the 21st century Wall Street has already triggered two $10 trillion crashes, two long recessions and an inflation-adjusted 20% market loss for Main Street’s retirement portfolios? And yet Wall Street’s cheerleaders just keep distracting investors with predictions of perpetual bull markets, ignoring the fact that we’re in the fifth year of an aging bull.

10 rules: Winning the loser’s game is no sell-bonds one-trick-pony

Main Street’s long-term investors need to look elsewhere for support. And one of the best sources for rational investors is Charles Ellis’s classic, “Winning the Loser’s Game: Timeless Strategies for Successful Investing,” which is coming out with a sixth edition soon. Ellis originally wrote it in the mid-1970s.

The legendary management guru Peter Drucker calls it “the best book on investment policy and management.” And Jack Bogle credits Ellis’s book as the inspiration for his first index fund at Vanguard in 1976.

The analogy behind Ellis’s title says a lot: Think tennis, golf or any sporting contest. There are two very different game strategies: The pros win the game by aggressively winning points against opponents. Amateurs win by exploiting the mistakes of their opponents. Same goes in the financial markets. Unfortunately today, amateurs don’t have a chance against the pros. We make too many mistakes. So we’re easy pickings for pros.

Ellis says the winning strategy for Main Street investors playing in Wall Street’s casino against killer pros is being patient, minimizing mistakes. Yes, follow his 10 rules and you can win the “loser’s game:”

1. Never speculate

Yes, the financial press acts like Nascar cheerleaders. One says jump on board now, this market is a “muscle car mired in the mud,” soon to get “unstuck.” Another tells investors to gamble: “For higher returns, you need to get into riskier investments.” No wonder Ellis coined the term, “Loser’s Game,” it’s accurate.

2. Your home is not a stock

You live in it. Today many mistakenly assume that rising equity values mean you don’t have to save for retirement. Or that you can use a home-equity loan to buy stuff. Or worse yet, use that money to buy more properties and start condo-flipping. Warning, when the bubble pops it will be too late for you to exit the loser’s game.

3. Save lots more regularly

“Savings glut” is the latest euphemism invented by happy-face economists and politicians. America’s savings rate has dropped from 10% two decades ago to zero, and has only recently started back up. Out-of-control consumption means importing and running trade deficits,. Meanwhile China recycles our dollars into Treasurys. This game is ending. Not saving now won’t help you later. Most retirees have too little set aside.

4. Brokers aren’t your friends

There is an inherent conflict of interest between you and every broker in the world. Even if they’re your neighbor and best friend. Bottom line: They make their living on fees and commissions, and that reduces your returns. They win and you lose. Think index funds.

5. Never trade commodities

Yes, you may want to add a small allocation of energy, metals or other commodity index funds to your long-term portfolio. But short-term trading is a loser’s game, and a fast one. Commodity traders tell me that all amateurs invariably lose all their risk capital within 12-18 months, then they quit trading.

6. Avoid new and exciting deals

Right now, with all the turmoil and risks domestically and globally, chasing hot stocks and exotic opportunities is an instant replay of the irrational exuberance that got us all in trouble with dot-coms in the 1990s, real estate around 2005-2008.

7. Bonds also ride up and down

Movie buffs used to say Fred Astaire was the greatest dancer of all time. Until a woman reviewer noted: Ginger Rogers was the greatest. She did the same as Fred, only backwards in high heels. Great visual when Charlie Ellis reminds us that in the short term bonds also go up and down like stocks. However, you increase your chances of winning the loser’s game remembering that as soon as the Fed increases rates, bond values will crash.

8. Never invest for tax benefits

Every year my accountant reminds me of this rule. Every decision should first make sense as an investment. Same applies if you’re making a business purchase like an SUV. Tax benefits are secondary.

9. Write your goals … and stick to them

Especially a well-diversified, long-term asset allocation strategy. A budget. A savings plan with regular money going into a retirement program. Career goals. And start living below your means now, save more now, because later will be too late. Put it in writing.

10. Never trust your emotions

Behavioral economics was launched when Ellis wrote the first edition of “Winning the Losers’ Game.” This new science makes it clear investors are their own worst enemy. We’re not rational. We’re too optimistic in spite of impossible odds.

The pros own the game, insiders own the casino, rig the tables. They have more information, get it faster than you do, got more chips to play with, and they spend all day playing … while you work for a living. You’re an amateur, at the loser’s tables, playing by their rules.

Worse, you can’t win because your emotions trigger too many mistakes, so they will set you up, trip you up and take advantage of your irrational brain.

Paul B. Farrell is a MarketWatch columnist based in San Luis Obispo, Calif. Follow him on Twitter @MKTWFarrell.

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