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Why Are You Buying a Stinkin' Bond Fund Now?

By Dr. Steve Sjuggerud
Wednesday, August 25, 2010

You're guilty... You're busted.
But it's not just you... Everybody is doing it. Everybody is buying bond funds.
As I'll show you, this is incredibly foolish.
First off, I know what you've done... I know 98% of the money that's flowed into the Franklin Templeton funds this year has gone into bond funds. The trend goes back farther...
For the last 30 months in a row, inflows into bond mutual funds have topped inflows into stock mutual funds. And the totals are just ridiculous... $559 billion has flowed INTO bond mutual funds in the last 30 months, compared to a $233 billion OUTFLOW from stock funds.
So you've sold your stocks and you've bought bond funds. But why?
Look, as I write, 10-year government bonds pay 2.48% interest. Meanwhile, the average bond fund charges 0.61% in annual fees. Think about that...
Right off the top, you're giving up 25% of the interest you'll earn to the bond fund manager. Why would you do that? Next, think about this: The BEST you can earn in interest in that bond fund is less than 2%. But the WORST case is really bad...
If interest rates happen to rise from 2.5% to 3.5% over the next 12 months, your principal (the amount you invested) will crash in value. A $10,000 investment would fall to $9,200. If interest rates rose to 5%, your principal value would crash to $8,200. Those numbers don't include any fees... That's just basic bond math.
If you held an individual bond, you could hold until maturity, and you'd be OK... you'd get your $10,000 back. But not in a bond fund... The bond fund manager may well sell losers at a loss, year after year. If interest rates go up year after year, bond fund losses will keep increasing year after year.
Do you really want to lend money to the government and earn less than 2% interest? Do you really want to have the risk of your principal (your initial investment) getting eaten away from both fees and potentially higher interest rates?
The miniscule interest is not worth the horrible risks.
Consider the early 1980s versus today: In the 1980s, when interest rates were in the high teens, nobody wanted government bonds. They were considered "certificates of confiscation." Investors were fearful. They weren't willing to accept 15% interest rates from the government, because the national debt was fast approaching $1 billion, which was one-third of GDP.
Today, with interest rates of 2.5%, investors are flocking to bond funds. Meanwhile, the national debt will hit $15 trillion and reach 100% of GDP next year.
Go figure.
Investors are scared of stocks... They haven't made any money in stocks in over a decade. Meanwhile, stocks are the cheapest they've been since the late 1980s.
You want to buy what's cheap and sell what's dear. That's how you make money investing.
Stocks are cheap. Meanwhile, bonds are dear. So what are you doing buying bond funds?
Good investing,

Further Reading:

If you want to wait to earn less than $300 lending money to the government for 10 years, "so be it," writes retirement guru Dr. David Eifrig. "But you can do better..." Learn how here: The Ultimate Way to Protect Your Money from Wall Street Scams.
Instant DailyWealth Classic: Even if you're not lending the government money, it still has both hands in your wallet. Get Porter Stansberry's full account – an essay dubbed "the best rant of 2009" – here: This Is Why There Are No Jobs in America.

Market Notes


We could call today's chart "a tale of two miners." It shows an extraordinary trend in place right now.
To tell the "tale," we put together a chart that plots the stock performance of Newmont Mining (black line) versus the performance of Vulcan Materials (blue line).
Newmont Mining is one of the world's largest gold miners. Newmont is up 23% this year because investors are flocking to "real money," gold... That's boosting gold stocks. Vulcan Materials is America's largest producer of construction aggregates like sand and gravel. Vulcan is down 29% this year because investors are skittish of owning anything that depends on "good time" construction spending.
You can see how this divergence in investor interest took place in May and June. And thanks to horrid job and manufacturing reports this month, the divergence has gotten even bigger. If the economy weakens further, expect this "gold stocks up, construction stocks down" divergence to keep running.

Gold stocks are rising while construction stocks are falling (year-to-date chart)

In The Daily Crux

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