The 1st Quarter in 2011 saw many of the markets continue their upward momentum from 2010. Below are the returns for some of the popular indices as of 3/31/11:
| Total Returns % |
1Q |
| Dow Jones Industrial Average |
+6.41% |
| NASDAQ Composite |
+4.83% |
| S&P 500 Index |
+5.42% |
| Russell 2000 |
+7.64% |
| U.S. Aggregate Bond Index |
-0.59% |
| MSCI All Country World |
+3.31% |
Source: Yahoo! Finance. Data through 3-31-11
If you’re a “conservative” investor, you may be alarmed at the only red/negative number above. Aren’t bonds supposed to protect your investments? Even if you don’t consider yourself to be a conservative investor, chances are you (or your advisor) have at least some of your money invested in bonds because that’s always been the best way to reduce risk in your portfolio. Unfortunately, that isn’t the case now, or for the foreseeable future.
The U.S. Aggregate Bond Index dropped below its 200-day exponential moving average (EMA) in early December last year. It was at that point that I sold my clients out of many of their bond holdings. As of April 1st, the index continued to be approximately 1% below its 200-day EMA. As interest rates continue to rise, bond prices will drop even more since they have an inverse relationship with interest rates. So where are investors to turn when looking to protect their portfolios from inflation?
Floating rate funds is one answer. These funds invest in senior loans which are very short-term loans (typically less than 90 days). The loans are made to non-investment grade businesses to finance expansion or acquisitions, or to refinance debt. The interest rate on these loans tends to be higher than most short-term debt instruments. To help ensure principal and interest payments are made on-time, senior loans have several important structural characteristics. First, they hold the highest rank as a creditor to a company, giving them priority over other creditors, bonds, and all preferred and common stock. Unlike bonds, which are unsecured (not backed by an asset), senior loans typically are secured by a first priority lien on the assets of the borrower. In the event of a borrower’s bankruptcy or other liquidation scenario, senior loan obligations would be paid first. The rate of interest on a senior loan floats with changes in market interest rates, so these investments react positively to rising rates. In a floating-rate investment, when interest rates rise, the amount of income also rises, but the price should remain generally the same.
In addition to floating rate funds, precious metals (gold and silver) and commodities are investments that can be used to hedge against inflation.
But didn’t Ben Bernanke and the government just tell us last month that inflation is not an imminent risk? Two highly respected investors, Warren Buffett and Bill Gross, commented in this Bloomberg article last week about the negative impact our country’s monetary policy is having on inflation and bond investments. If that isn’t good enough, Wal-Mart U.S. CEO Bill Simon told USA Today last week that he expects inflation is “going to be serious.”
Is your portfolio being protected from inflation and our country’s current economic policy? It continues to amaze me that “advisors” on the radio, TV, or in print continue to talk about how important it is for investors to stay the course with their bond investments. Just as baffling is why advisors continue to neglect gold and silver as an investment in their clients’ portfolios.
If you or someone you know would like an analysis of your current investment portfolio, please call me to schedule your free consultation – 913.693.7918.
John P. Chladek, MBA, CFP® is the President of Chladek Wealth Management, LLC, a fee-only financial planning and investment management firm specializing in helping families and couples who are not yet retired realize their financial goals. For more information, visit http://www.chladekwealth.com.
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