Global View Investment Blog

5 Reasons You Shouldn’t Invest in Bond Index Funds

Investors have missed the memo: Investing in bond index funds is foolish. Why? I’ll give you 5 reasons. As a financial advisor Greenville SC for many years, I have learned the ins and outs of bonds.

 

1. Most bond owners aren’t even trying to make money

The most important thing investors need to know about bonds is this: The big banks and insurance companies buy bonds for reasons other than making money. This is why investors shouldn’t invest in them.

The truth is that regulations force the buying and selling of more than half of the global bond supply. Not only are the two largest bond mutual funds index funds, but most new money is flowing into bond index funds.

What’s worse is investors in the largest bond funds aren’t even keeping up with the index.

It may be hard to believe, especially after the financial crisis, but more than half of bond owners don’t have economic motives. They own bonds because of government regulations.

Central banks, commercial banks and insurance companies buy and sell bonds to satisfy rules and regulations that have nothing to do with making money. And this means the last thing you should do is copy what they do!

Let me say it again: More than half of the $102 trillion global bond market is controlled by central banks, commercial banks and insurance companies whose primary motive is something other than making money when they purchase bonds!

 

Contact Global View to schedule a review of your current financial plan.

 

2. You may be investing without a goal of making money

The financial services industry is a confusopoly, and because of this, you may be investing without a goal of making money.

A confusopoly is an industry that profits at its customers’ expense by intentionally making them confused. Wall Street is the biggest confusopoly ever.

Everyone wants to own what they know and are comfortable with (this happens to advisors too). And for many people, that’s U.S. stocks and bonds. Unfortunately, hardly anyone knows that you can reduce risk and increase return by thinking outside the box.

Here is Global View’s philosophy on how to properly build an investment portfolio.

 

3. Interest rates may be rising, making it harder to make money in bonds

When funds get large, investors should be concerned about falling returns and increased risk.

In 2016, we believed simulative fiscal policy would likely lead to rising rates. Because of this, we repositioned our bond portfolios. This has been working better than we expected!

The outlook for traditional bonds is not good. Rates fell from 1980 through 2016. But since then, they have been in a rising trend. And while much of the quick rise may be behind us, that is not a certainty.

Remember, mortgage-backed securities were issued to poor-credit quality homeowners whose credit has improved. Banks are forced to sell these. We can buy them.

Second, banks can no longer lend to private companies. This creates an opportunity to get equity-like returns with substantially less risk if the bond holder is willing to hold until maturity. Investors can access these through bond funds that are liquid quarterly (not daily).

 

4. Long U.S. Treasuries are what most bond owners are buying

In 2017, more than 90 percent of all inflows into bond exchange traded funds went into index funds. I did a quick study of the top bond funds, and the two largest are Vanguard bond index funds. These two funds have more than $300 billion in bonds.

In the last 15 or so years, the bond index (Morningstar U.S. Intermediate Core bond index) made 4.14 percent. And while investors can’t invest in an index, they could have invested in the Vanguard Total Bond Market Index. This fund made 3.70 percent per year, but investors in it only made 3.24 percent. That’s typical of the average bond investor experience for this period, which was 3.23 percent.

In fact, the average return investors made in the 30 largest bond funds are terrible. For the last one-, three- and five-year periods, investors made less than 1 percent per year. And for the last 10 to 15 years, they made only about 3 percent.

This was all during a bond bull market (when interest rates were rising).

These larger bond funds are the funds investors own in their company 401ks; the bond funds they are buying on their own; and in fact, the bonds that most advisors are using. It includes the Vanguard Total Bond market indexes, Dodge and Cox Income and other well-known funds that are probably in your company 401k or IRA.

 

5. Bond owners don’t do the right thing 

Finally, volatility in bond markets creates special situations. Remember, with a $102 trillion global bond market, and more than 30,000 publicly traded companies, there are a lot of different bonds out there. Many of them are mispriced. Every day.

Unfortunately, many bond owners are not doing the right thing. Then, new bond owners follow suit. It’s a terrible cycle.

Don’t make the same mistakes other bond owners are. Talk with a financial advisor in Greenville, SC who can help you invest in the right things.

 

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Ken Moore

Written by Ken Moore

Ken’s focus is on investment strategy, research and analysis as well as financial planning strategy. Ken plays the lead role of our team identifying investments that fit the philosophy of the Global View approach. He is a strict adherent to Margin of Safety investment principles and has a strong belief in the power of business cycles. On a personal note, Ken was born in 1964 in Lexington Virginia, has been married since 1991. Immediately before locating to Greenville in 1997, Ken lived in New York City.

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