The False Safety of Bonds
One of the things that I’m most worried about right now is people taking money that they want to keep safe and trying to find investments that earn a yield that’s a little higher. This is called “stretching for yield,” and it can be be a dangerous game, especially if you don’t understand the rules.
The problem starts innocently enough. People realize that their safe money is earning about zero sitting in a money market fund. So they begin looking for a better place to put it, leading them to a bond fund. The common perception of bond funds is that they are safe. But as yields in bond funds have come down, people have searched for funds with higher yields.
This is where things get dangerous. Remember this is “safe” money, and the last thing you want is to lose any of that money. Watching the value of your stock funds go down is painful, but watching the value of investments that you thought were safe fall is a real bummer. In some ways, it’s worse, because you didn’t think it could happen.
So please remember this one point: Bond funds can (and do) lose money!
In fact, when you are comparing bond funds, it’s often helpful to replace the word “yield” with the word “risk.” So when you read “High-Yield Bond Fund,” you should start by thinking “High-Risk Bond Fund.” This does not mean that high-yield bond funds are bad, but it does mean that you should be very careful about trying to find a bond with a high yield to buy with your safe money.
The moment you try to get a higher yield, you’re taking on more risk, and sometimes the level of risk can be surprising. You don’t have to go back far to see examples of this. In 2008, there were plenty of bond funds that were down more than 20 percent, and others that were almost flat. Just because it says “bond” does not mean it will be “safe.”
Let me be clear: I’m not saying that high-yield bond funds are bad. I’m not saying that investing in bond funds is bad. I’m trying to make it clear that as soon as you start looking for a higher yield, be aware that you’re probably taking on more risk. So don’t be surprised when you lose money in what you thought was a safe investment.
This sketch and post originally appeared in the New York Times on March 29, 2010.