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Time to Dump Treasurys?

Just how low can Treasurys go? As the Dow Jones Industrial Average was falling more than 400 points today, the yields on Treasurys plunged to a new all-time low, falling below the 2.0% mark for the first time. For many advisers and investors, the drop served as another wake-up call that it may be time to ditch the government bonds.

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Bill Gross, the fund manager of the world’s largest bond fund at Pimco, has long been bearish on Treasurys, but also said recently that a recession is likely. (Which would actually be good news for Treasury bonds.) And in the past few months several advisers and bond fund managers have also moved out of the government bonds, which pay low yields and are most susceptible to losses from rising interest rates, analysts say. That’s what pushed Russell Francis, a financial adviser in Beaverton, Ore., to move his clients largely out of Treasurys a month ago. “The yields are so low right now that they pretty much have nowhere to go but up over the next six months to a year,” says Francis.

Despite their low yields, investors continue to flock to Treasurys for their liquidity and low credit risk. The bonds rallied Thursday as fears of a global economic slowdown peaked, pushing yields to their new low. (Bond yields fall when rates rise and vice versa). But critics say the rally can’t be sustained and worry the bonds, especially those with longer maturities, are likely to lose money if interest rates rise. Their low yields mean investors have little cushion to protect themselves from such losses.

“Owning Treasurys right now just means you’re not getting much of a return and it means you’re taking on a lot of interest rate risk,” says David Morgan, a principal with JMG Financial Group, a financial advisory firm based in Oak Brook, Ill., who recommends his clients hold Treasury Inflation-Protected Securities to guard against inflation, but doesn’t allocate money specifically to pure Treasurys. Francis is instead creating bond ladders with municipal bonds, Build America Bonds and investment grade corporate bonds. He says holding individual bonds instead of investing through a mutual fund protects his retiree and pre-retiree clients from price movements due to interest rate changes. By holding their bonds to maturity they can be sure to get their principal returned in full. The yield advantage they have over Treasurys could also offset losses due to rising rates, he says.

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    • Pete,

      What Mike was pointing out is that if you sell your bond before it matures and the current interest rate is higher than when the bond was issued, then you will take a loss because no one will buy it from you at the price you originally paid. If you held it to maturity, you could cash it in for your original purchase price, plus the original interest.

    • Mike -
      If rates rise it is irrelevent whether you hold an existing bond to maturity or sell it and buy a higher yielding one. Try the math; there is no differece in total return.

    • John Exter was A fed governer and work closely with the bullion banks when Nixon closed the gold window, from a 1991 Interview:

      EXTER The most important one is this flight to currency. It is bigger than anything I expected right now. We are still having troubles with banks, thrifts, insurance companies, & others, which will cause more people to move down to Treasury bills & currency. At some point they will go to gold. We’re at the threshold of that point. When they go to gold instead of currency or Treasury bills, the price of gold will take off. It will be a bandwagon everyone will want to get on. Then even those who have bought currency will see how foolish they were & that gold is far better to hold … than currency, that it is the best store of value money man has ever found. It’s stupid for people to hold currency. The Fed can simply print all they want at very low cost. Paper money is as abundant as leaves on trees.

    • Hey ktf… assuming there is no default holding a bond to maturity does assure the holder a return of their principal. I realize you are trying to be cute and bring up inflation, but that is an entirely different argument and deals with a risk in a loss of buying power. The article was clearly pointing out that in a “bond fund” where bonds are constantly bought and sold there is significant risk of loss of principal (yes actual principal without getting cute about inflation). That risk is not there when holding individual bonds to maturity (other than default of course).

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