February 12, 2010, 5:29 am

Investing Ideas for 2010: When Bonds are Riskier than Equities

by: The Financial Blogger    Category: Investment, Market and Risk
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Last week, I attended our monthly financial planning meeting where we  reviewed the current and upcoming economic situations and learn about our trading department’s expectations about the market.

I am always eager to know which observations have been made by our trading floor and their potential to see the future. But more than this, what I really like about these meetings is to see how they translate economic signs into market trends.

Don’t worry, I am not going to delve into the marvellous world of predictions (there are plenty of financial reporters to do that 😉 ). I did, however, want to bring up an interesting point if you are looking for investment ideas for 2010: Bonds will be riskier than equities!

Say what? How can a “relatively” secure and guaranteed investment be riskier than “volatile”, unsecured shares of a public company? This is because of the bond value mechanism!

In fact, if you are looking for investment ideas for your 2010 RRSP, you should look towards equities for 3 reasons:

#1 Bond values drop when interest rates go up

If you want a full explanation as of to why bonds go down when interest rates go up, I suggest that you read this article over at Gather Little By Little. In a few lines, let just say that each time interest rates go up, existing bond values drop to reflect the new interest rate environment. Therefore, the buyer of an existing bond, will pay lower than it’s initial (face) value (let’s say $980 instead of $1000) and the $20 difference, he will receive at maturity (because the company will pay him back $1000 even if he had paid only $980), will be added to the current interest rate of the bonds to mimic the new (and increased) interest rate on the market.

Since everybody agrees that interest rates should slowly go back up toward the end of 2010 /  beginning 2011, bond value4 should drop accordingly during this period.

#2 Bonds are offering very low interest rates right now

Combined with the fact that new bonds are offering very low interest rates, if they have to drop in value, chances are that your yield will be around 0%…. or even worst; some bond funds or mortgage-backed funds will probably show negative returns in 2010 – 2011. Not the best investment ideas then ;-).

#3 We still have another 25% + to reach the market highs of 2008

On the flip side, stock markets are down at least 25% from their market highs of 2008. In some cases, the appreciation required is more than 30%! While I won’t say stock markets will recover fully from all their declines in 2010, chances are that they will continue to appreciate during the next 12 months. Economic data are stronger and several companies show liquid assets and profits.

Investment Ideas for 2010:

So based on these premises, I have selected a few investment ideas for 2010. Since I think that the stock market is a safer place than bonds, I have only picked equity related investment solutions:

#1 Variable Rate CD’s

While variable rate CD’s and linked notes are not part of my favourite investments, this is probably your only option if you wish to keep a guaranteed investment that will beat the inflation over the next 5 years. The market offers about 3% for a 5 year certificate of deposit. Do you really think that inflation won’t take at least 50% of this yield in the next 5 years? This is why variable rate CD’s is a great investing ideas for 2010. They offer a guaranteed investment while their yield is linked to different stock markets. Make sure to understand how it works and ask several questions to your financial advisor before going with this option.

#2 Packaged Mutual Funds

If you don’t know much about how the stock market works but you don’t worry too much about your portfolio fluctuations, you can look at packaged mutual funds. Funds are invested according to your investor profile to make sure they respect your risk tolerance. The good side of packaged mutual funds is that they are automatically rebalanced every 6 months to make sure they stick to your investing strategy. Therefore, you don’t have to actively follow your investments. While packaged mutual funds are great investing ideas, they also show very high management fees (MER’s).

#3 ETF’s

I really like ETF’s since their MER’s are pretty low and you buy what you want to follow. There is an ETF’s for anything you want to follow from stock indexes to industries or commodities. I would say that the major downside of ETF’s is that there are too many out there ;-). If you decide to build a ETF’s portfolio, make sure to follow it and rebalance it every 6 months. If not, you may have a big surprises!

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by: Jineshwar singh | February 12th, 2010 (5:02 pm)

yes, the bond price is inversely proportional to rate of interest. But the yield to maturity is directly proportional to the interest rate. If the bonds are of short duration, the rise in the interest rate is not very harmful. The main thust of investment should be towards the diversification in the asset allocation.