Markets Can Be Scary but More Importantly, They are Resilient
Most investors understand or perhaps accept the fact that they are not able to time stock markets (sell out before they go down or buy in before they advance). The simple rationale is that stock markets are forward looking by anticipating or “pricing in” future expectations. While the screaming negative headlines may capture attention, stock markets are looking out to what may happen well into the future.
When it comes to interest rates and inflation, my observation is that the opposite is true. Most investors seem to think they can zig or zag their bond investments ahead of interest rate changes. This is perplexing as you can easily make the case based on evidence that trying to time bond markets is even more difficult than trying to time equity markets.
Another observation is that many investors tend to be slow to over-react. Reacting to today’s deafening headlines ignores that fact that all financial markets are extremely resilient. Whether good or bad economic news, good or bad geopolitical events, markets will work themselves out and march onto new highs, albeit sometimes punctuated by sharp and unnerving declines. Put another way, declines are temporary, whereas advances are permanent. And remember, this applies to both bond and stock markets.
It is easy to understand why we might be scared about the recent headline inflation numbers and concerned about rising interest. It is very important to keep this in context, which is what we will address today.
With interest rates in flux, what should you do? Consider this…
Positioning for Inflation – Dimensional Fund Advisors
Also, check out DFA’s video: How to Think about Rate Increases
But as it relates to your immediate fixed income holdings we don’t recommend reacting to breaking news. A recent Dimensional Fund Advisors paper, “Considering Central Bank Influence on Yields,” helps us understand why this is so. Analyzing the relationship between U.S. Federal Reserve policies on short-term interest rates versus wider, long-term bond market rates, the authors found:
“History shows that short- and long-term rates do not move in lockstep. There have been periods when the Fed aggressively lifted the fed funds target rate—the short-term rate controlled by the central bank—while longer-term rates did not change or “stubbornly” declined.”
What is fixed income investing and what role does it play in your investing?
Fixed income investing is a timely conversation, given the current climate of ho-hum returns and continued uncertainty over when or if these conditions may change.
Armed with understanding, it becomes easier to make sense of the never-ending onslaught of news and wide array of investment choices. Fortunately, a few basic principles can guide the way. Overall, they are based on optimizing the components of fixed income investing that are more readily within our control and avoiding becoming hamstrung by those that are not.
Fixed Income Investing Principles
#1: Invest According to Plan
#2: Let the Evidence Be Your Guide
#3: Bonds Are Safer; They’re Not Entirely Safe
#4: Structure Your Fixed Income Holdings for the Job at Hand
In a CNBC interview, Warren Buffett said,
“in terms of bonds, some day they will sell (at a) yield a whole lot more than they’re yielding now … They’re terrible investments right now.”
Well, he actually said this almost 9 years ago in a May 2013 interview. Since that time, bond returns have outpaced inflation by 1 to 2% per year, or pretty much in line with historical averages.
Let’s be clear on one thing: if your personal portfolio, risk tolerance, and risk capacity are the same as Warren Buffett’s, then perhaps a large amount of your portfolio in bonds may not make sense. But not everyone is Warren Buffett and this topic warrants deeper analysis.
Stop Over-Reacting to Market Headlines and Trust Market Resiliency
It is extremely important to remember that bonds play an important role in a properly diversified portfolio. Reacting or perhaps over-reacting to potential interest rate increases, recent high inflation, or recent poor returns of many bond investments is unlikely to be successful strategy. Let the evidence guide you as the markets are resilient.
Concerned about inflation, interest rates, and market reaction?
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