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Bond Bubble?

Bond Bubble?

As interest rates have spiraled downward over the past decade, driving bond prices upward, many in the financial media have suggested that bonds and other fixed income instruments should be shunned and that bonds have entered “bubble territory.” With all of this discussion going around, it is important to understand what constitutes a bubble and what type of assets are affected by these events.

A bubble is typically defined as the aggressive appreciation of an asset far beyond a reasonable estimation of intrinsic value. One of the most memorable bubbles of the recent past was the so called “dot-com bubble.” During the late 1990s through early 2000, technology stocks appreciated to levels that could not be supported by fundamentals. The tech-heavy Nasdaq reached an all-time high of 5132 in March of 2000 before declining by almost 80% to 1108 in 2002.  Although there has been significant recovery in the Nasdaq, those who invested at the peak of the tech bubble over ten years ago, would still need to see the index appreciate by 90% just to get their original principal back! The problem as an investor is, if the decline is too great, the probability of timely recovery is remote and actual wealth destruction (as opposed to paper losses) takes place.

A bond is a much different type of asset than a stock or other capital asset as it is a contractual obligation to re-pay a loan at the end of a defined period of time. A stock by contrast involves no contractual obligation and the owner of such an asset is only entitled to the earnings after all other stakeholders have been paid. Therefore, the value of a stock at any time is subject to many more variables than a bond and is based on the perception of what those earnings will be at some point in the future. A bond by comparison, assuming the borrower/issuer is not bankrupt at the end of the contractual period, must return the principal amount owed in full. This fact makes the value of the bond much more ascertainable than that of a stock since at least as a bondholder/lender, I have a legal claim to an absolute value at a definitive point in the future. Therefore, since the ultimate value of a bond is known and there is no reasonable expectation of receiving more than the principal value at maturity, bonds can never really appreciate to levels that would constitute what we typically consider to be a bubble. 

The other argument often made today is that given low interest rates, investors should only buy very short-term bonds (if they buy bonds at all) as interest rates are sure to rise at some point in the future. The problem with this type of analysis is that it doesn’t take into consideration the opportunity cost of significantly less interest in the early years. Take for example, a U.S. Government bond issued at 3.4% (yield as of the date of this writing) with a ten-year maturity. One might argue that 3.4% annually is a paltry amount to accept over a ten year period and that one should shun this investment in favor of a very short-term instrument that would benefit from steadily rising rates.

Let’s examine this by contrasting the benefits of a 10-year U.S. Government bond paying a fixed 3.4% versus a two-year U.S. Government bond at the current .6%. Let’s assume that interest rates will rise 1.25% every two years such that the two-year bond in the example above would begin at .6% and would be renewed at 1.85%, 3.1%, 4.35%, and finally 5.6%. Many people would opt for the short-term bond in this example, but if the calculations are done, the better investment (assuming a ten-year holding period), would be the 10-year U.S. Government bond at a constant 3.4%. In this example, the 10-year U.S. Government bond held to maturity would generate $3,000 more in total income than the bond renewed every two years at subsequently higher rates.

What this example teaches us is that one should always run the numbers when making decisions as opposed to making assumptions or subscribing to conventional wisdom. The more important consideration is to make certain that the investment is made within the context of the proper time horizon and liquidity needs.

In summary, we are not of the belief that bonds as an asset class are in a classical “bubble,” nor do we believe that one should only opt for ultra short-term instruments. At MutualWealth, we continue to view bonds as an important asset class that has proven over time to diversify risk and generate a consistent stream of income. Although bonds may suffer through periods of rising interest rates, they will continue to serve a purpose in portfolio diversification and income production. With respect to strategy and individual security selection, we believe we serve our clients best by making investment decisions at the margin based upon actual analytical analysis as opposed to generic philosophical presumptions. As always, if you have concerns about the interest rate environment and the potential impact on your investments, please feel free to contact us at any time.               

Shayne Nagy, CTFA
Senior Vice President
Trust and Investments 


Contact a Representative Today

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    Granger, INDIANA – MutualBank welcomes Brent...

    Thursday, June 25, 2015

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Personal Social Media Account Security

For many of us, social media has become a part of our everyday lives and helps us conveniently keep tabs on the people and topics we care most about.

Recently however, there has been an increase of social media account take overs by cybercriminals. As stated in the media, one contributing factor in some of the social media account takeovers has been the use of weak passwords.


Tips for creating a stronger password:


  • Passwords should typically:
    • be at least 8 characters in length
    • contain at least 1 number
    • contain at least 1 special character (!@#$$%)
    • contain both upper and lower case characters.
  • Do not use your name, date of birth, maiden name, mother’s maiden name, address, or other easily guessable words for passwords. 
  • Another way to create a strong password is to use a series of words that do not relate to each other. For example, JumpingFastRelaxStop!#.

 


Social media additional security options:


Another way to help avoid social media account takeover is to use the additional security options available. Two-factor authentication adds an extra layer of security that drastically decreases your chances of account takeover. Two-factor authentication is essentially the using of two separate components to verify your identity, the combination of something you HAVE with something you KNOW. A good example of two-factor authentication you most likely are already used to is withdrawing cash from an ATM, for example. Having both your debit card AND knowing a pin number is required to complete the withdrawal and protect your identity.

A popular and convenient two-factor authentication method is using a combination of both an online password and a text message verification sent to your phone. Enabling this type of authentication typically follows this process:

  1. Enter your password into Facebook or another website
  2. Immediately receive a text on your phone with a temporary pass key
  3. Enter the passkey received back on the site/app and you’re logged in

This may seem like overkill, but enabling this two-factor authentication will drastically decrease the chances of your social accounts being hacked. And actually, the process of setting up and using this authentication is pretty simple and convenient.

 


How to enable two-factor authentication:


Many popular social networks like Facebook, Twitter, LinkedIN, and others already support two-factor authentication. To learn more about how to do so on the most popular sites on the web, be sure to check out this article:

http://socialcustomer.com/2014/04/how-to-enable-two-factor-authentication-on-50-top-websites-including-facebook-twitter-and-others.html

Wednesday, April 22, 2015

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Bond Bubble?

Bond Bubble?

As interest rates have spiraled downward over the past decade, driving bond prices upward, many in the financial media have suggested that bonds and other fixed income instruments should be shunned and that bonds have entered “bubble territory.” With all of this discussion going around, it is important to understand what constitutes a bubble and what type of assets are affected by these events.

A bubble is typically defined as the aggressive appreciation of an asset far beyond a reasonable estimation of intrinsic value. One of the most memorable bubbles of the recent past was the so called “dot-com bubble.” During the late 1990s through early 2000, technology stocks appreciated to levels that could not be supported by fundamentals. The tech-heavy Nasdaq reached an all-time high of 5132 in March of 2000 before declining by almost 80% to 1108 in 2002.  Although there has been significant recovery in the Nasdaq, those who invested at the peak of the tech bubble over ten years ago, would still need to see the index appreciate by 90% just to get their original principal back! The problem as an investor is, if the decline is too great, the probability of timely recovery is remote and actual wealth destruction (as opposed to paper losses) takes place.

A bond is a much different type of asset than a stock or other capital asset as it is a contractual obligation to re-pay a loan at the end of a defined period of time. A stock by contrast involves no contractual obligation and the owner of such an asset is only entitled to the earnings after all other stakeholders have been paid. Therefore, the value of a stock at any time is subject to many more variables than a bond and is based on the perception of what those earnings will be at some point in the future. A bond by comparison, assuming the borrower/issuer is not bankrupt at the end of the contractual period, must return the principal amount owed in full. This fact makes the value of the bond much more ascertainable than that of a stock since at least as a bondholder/lender, I have a legal claim to an absolute value at a definitive point in the future. Therefore, since the ultimate value of a bond is known and there is no reasonable expectation of receiving more than the principal value at maturity, bonds can never really appreciate to levels that would constitute what we typically consider to be a bubble. 

The other argument often made today is that given low interest rates, investors should only buy very short-term bonds (if they buy bonds at all) as interest rates are sure to rise at some point in the future. The problem with this type of analysis is that it doesn’t take into consideration the opportunity cost of significantly less interest in the early years. Take for example, a U.S. Government bond issued at 3.4% (yield as of the date of this writing) with a ten-year maturity. One might argue that 3.4% annually is a paltry amount to accept over a ten year period and that one should shun this investment in favor of a very short-term instrument that would benefit from steadily rising rates.

Let’s examine this by contrasting the benefits of a 10-year U.S. Government bond paying a fixed 3.4% versus a two-year U.S. Government bond at the current .6%. Let’s assume that interest rates will rise 1.25% every two years such that the two-year bond in the example above would begin at .6% and would be renewed at 1.85%, 3.1%, 4.35%, and finally 5.6%. Many people would opt for the short-term bond in this example, but if the calculations are done, the better investment (assuming a ten-year holding period), would be the 10-year U.S. Government bond at a constant 3.4%. In this example, the 10-year U.S. Government bond held to maturity would generate $3,000 more in total income than the bond renewed every two years at subsequently higher rates.

What this example teaches us is that one should always run the numbers when making decisions as opposed to making assumptions or subscribing to conventional wisdom. The more important consideration is to make certain that the investment is made within the context of the proper time horizon and liquidity needs.

In summary, we are not of the belief that bonds as an asset class are in a classical “bubble,” nor do we believe that one should only opt for ultra short-term instruments. At MutualWealth, we continue to view bonds as an important asset class that has proven over time to diversify risk and generate a consistent stream of income. Although bonds may suffer through periods of rising interest rates, they will continue to serve a purpose in portfolio diversification and income production. With respect to strategy and individual security selection, we believe we serve our clients best by making investment decisions at the margin based upon actual analytical analysis as opposed to generic philosophical presumptions. As always, if you have concerns about the interest rate environment and the potential impact on your investments, please feel free to contact us at any time.               

Shayne Nagy, CTFA
Senior Vice President
Trust and Investments 


Contact a Representative Today

Back to Education Resources

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