Though stock selloffs and the sharp Dow downturn took center stage this week, there is another market movement happening that’s far more optimistic: bond yields are spiking after an almost 10-year decline. The U.S. 10-year Treasury bond hasn’t had a return level this high since 2011 and the uptick could be indicative of the economy’s future direction.
Still, investors might wonder how they can keep their money secure and rising, especially when the market is ebbing and flowing a little more fervently than usual. Should they take immediate action or sit back and wait? Today, let’s discuss the relationship between stocks and bonds and how the movements of each can positively or negatively affect your overall investment portfolio.
How the U.S. Treasury Bond is Different
As a general rule, index funds that follow the S&P 500 tend to generate a higher yield than benchmark bonds provided through the U.S. Treasury. When the 2008 financial crisis hit the economy, the Federal Reserve adopted a new policy of lower interest rates aimed at keeping reserves conservative. As a result, bond yields weren’t able to grow too high. This directly affected both those looking to save for the long-term as well as those who had such bonds included in their diversified portfolios.
Seeking higher returns elsewhere, many concerned investors opted to move their money around during this sensitive time. For many, longer-term bonds were the answer, as they tend to carry higher overall yields than those with a shorter term. Others looked toward overseas investments as a point of rescue while still more turned to equity markets.
Yet, that was then and this is now. Today, the economy is on the uptick, with the national gross domestic product (GDP) moving past 4% in the second quarter of 2018 and anticipated to top 3% as we round out the year. Just last month, unemployment rates dipped to the lowest they’ve been in almost 50 years. This means that interest rates that used to be kept low are now rising, but how does this affect investors?
The Rise of Federal Interest Rates
As the economy continues to recover, the Federal Reserve is loosening its grip on interest rates. This is both in response to the growth as well as an effort to prevent inflation and better control the broader economic environment to prevent another recession from occurring. Historically, a rise in these interest rates equals a rise in bond yields, hence the recent improvement investors have seen in this sector. Why? Future-focused investors are pulling their money out of stocks and instead putting them into entities that traditionally give safer and higher returns, with bonds being one of them.
As the market experienced its dramatic turns this week, there remained strong evidence through recent economic data that Federal interest rates wouldn’t be lowering any time soon. Almost simultaneously, bond yields rose and bond prices fell in turn. So, does this mean everyone should run directly toward investing in bonds? Let’s take a closer look.
The Impetus to Buy Into Bonds
Though a shift like this often causes anxious investors to move their money away from riskier stocks and into more sturdy and secure bonds, you shouldn’t necessarily rush out and create a gift certificate for that newborn baby in your life just yet. Though bonds were traditionally given as gifts to infants in hopes that the money would mature as the baby did, this was often done without deep insight into how the current market might change and directly affect the bond’s profitability. Today, we know that unless bond yields reach at least 5%, equity investors shouldn’t rush to make any major moves.
Rather, interested investors should instead wait to see how far bond prices will dip. Especially for those who have a long-term retirement portfolio or 401(k) plan, it’s always wise to keep your accounts diversified to ensure a balance among all entity types. Consider how risk-averse you are and what level of liability you’re willing to adopt. Then, check back in regularly with your financial advisor to make sure your current mix will meet your needs down the road and make any necessary adjustments from there, rather than jumping at a major market turnaround like this one.
