Talk about a fast turnaround!
Just over a week ago, everyone I knew was talking about GameStop.
The stock rallied from a few bucks a share to a peak of $483 in just a few months. And the majority of the move took place in just two weeks!
Of course, whenever you get a manic bubble like this, reality is sure to set in eventually.
While the smoke is still clearing (and there are still plenty of true believers in this stock), shares spent the last several sessions falling from that $483 high to Friday’s close at $63.
My guess is that GameStop still has a lot farther to fall.
Well-publicized moves like this always come with the personal stories of fortunes made and lost.
If you’ve been following this story from the beginning, I don’t have to tell you about the millionaires that were made as speculators took on risky positions and wound up with wealth beyond their wildest dreams.
Less publicized (but probably more prevalent) are the stories of those who bought at the top and lost tremendous amounts of money as the stock came back to earth.
Similarly, there are plenty of people who took this ride for an entire round trip, making millions in a few short days only to give it back just as quickly.
It’s hard to feel too sorry for these people because it was well known that shares of GameStop were volatile and risky.
So traders who knowingly took the risk shouldn’t be that surprised when the shares traded lower.
But I want to talk about a different mania in the market…
One that you very likely are already participating in without even knowing it…
And one that will likely devastate far more retirees than the GameStop saga could ever have touched.
I don’t want you to get caught in this trap. So today, I want to warn you about the dangers of this much more widely accepted retirement investment.
The Most Widely Held Retirement Asset
The “conventional wisdom” you get from a traditional wealth manager can be some of the most dangerous advice you can get these days.
I’m sure most of these financial advisors mean well.
At least I hope they have your best interest in mind. I’m sure some of them are just in the business to make money and don’t really care about their clients.
But I digress…
For many years now, investment professionals have recommended that retirees use the “Age Rule” to determine how to divide up their assets.
The Age Rule simply states that you should subtract your age from 100 and put that percentage in stocks. The rest should be invested in bonds (primarily Treasury bonds).
So if you’re 50 years old, most advisors think you should have half of your money in stocks and half in bonds.
At 70 years old, only 30% of your money should be in stocks and the rest in Treasury bonds.
That formula may have made sense two decades ago when investors could generate close to a 6% yield on these Treasury bonds. But in today’s environment, that’s downright dangerous!
As I’ve mentioned here at Rich Retirement Letter before, Treasury bonds are a ticking time bomb in many investor’s accounts.
And with so many retirees being advised to invest half… or two-thirds… or sometimes much more of their wealth in these dangerous bonds, I worry that losses for retirees will make the GameStop story look like child’s play!
I couldn’t live with myself if I didn’t warn you about this danger. So today, I wanted to share a bit more about why these “safe” investments are a trap for all too many retirees.
What Happens When Interest Rates Move Higher?
You may have heard people talk about how bond prices trade lower when interest rates move higher. But it’s important to understand why this happens and how far bond prices could drop.
Every Treasury bond is set to pay investors a fixed “coupon” every six months. This is the income you receive, and it won’t change for as long as you hold the bond.
In addition, every Treasury bond pays investors a $1,000 principle when the bond matures.
Since these payments are guaranteed by the U.S. government (which can print money to pay its obligations), Treasury bond payments are considered to be fully “guaranteed”.
That’s the good news.
The bad news is that as market interest rates rise, the price of Treasury bonds that have already been issued must adjust.
Let’s say a bond pays a 2% coupon every year and market interest rates are also at 2%. That bond should trade at $1,000 — its principle price.
The $1,000 price makes sense because if you own that bond, you’ll get paid a 2% yield every year and get your money back when the bond matures.
But if interest rates move up to 4%, the bond price must trade lower.
That’s because buyers will only want to buy the bond if they can realize a 4% annualized return over the time they hold it.
And since the bond only pays 2% in coupon payments, the bond has to start at a lower price.
This way, a buyer today who purchases the bond at a lower price can combine the 2% coupon payment with the gradual rise in the bond price…
So when they get their $1,000 back at the end of 10 or 30 years (whenever the bond matures), they’ll get a full 4% annual return over that period of time.
The math and logic on this type of trade can be a bit confusing at times.
But the bottom line is that when interest rates move higher, bond prices trade lower. And that’s a scary thing for retirees who hold huge positions in Treasury bonds!
Why Bonds Are Set to Lose Value… How Bad Could It Get?
We’ve talked before about how new policies from the Democrats’ leadership in Washington could spark inflation.
When inflation starts to rise, the Fed’s primary tool to stabilize prices is to increase its target interest rate.
And we’re already starting to see the interest rate market move higher in anticipation of this policy shift.
Take a look at a longer-term chart of the yield on 10-Year Treasury bonds and you’ll see that yields are very very low compared to other times in history…
And that they’ve actually started moving higher in recent months.
The chart above shows the 10-Year Treasury bond at 1.19%. And you can see that in the past, rates have been much higher.
Before the financial crisis of 2008, the 10-Year Treasury bond was near 5%. And at the turn of the century, 10-Year yields pushed above 6%.
You might think this is ancient history.
But we’ve been living in a time of very low headline inflation, which has kept interest rates abnormally low.
If (and when) inflation comes back, interest rates could surge higher — and very quickly at that!
The sobering thing for retirees is how quickly bond prices could fall as this happens.
Statistically, the 10-Year Treasury bond has a “duration” of 9.3. That’s simply technical speak for how these bond prices are affected by a change in yield.
In the case of the 10-Year Treasury bond, we can expect to see a 9.1% decline in the price for every 1% that yields rise.
Imagine what would happen if yields rose back to the 5% level we had not long ago. That could cause the value of your bond holdings to drop by more than 30 %!
Now do you see why I’m so worried about this shift?!
It gets even worse if you consider 30-Year Treasury bonds. First, I’ll show you the yield chart below.
The yield on the 30-Year bond is currently about 1.93%. These bonds were also trading with a yield near 5% before the financial crisis.
And you might think that there’s less risk because there’s only about a 3% difference between the current yield and where 30-Year bonds were trading before the crisis.
But because of the longer time frame of these bonds, prices are even more susceptible to changes in interest rates.
The current duration on the 30-Year bond is calculated at about 23. That means the bond will lose 23% of its current value due to a 1% rise in rates.
Hopefully, you know me well enough to understand that I’m not giving you these statistics to worry you.
Here at Rich Retirement Letter, our goal is to help you set up your retirement so you don’t have to worry and so you can focus on the things that really matter in life!
But to have that sense of security, you must understand the risks here and invest in a way that minimizes your risk.
If you haven’t already, please take a look through your investment accounts and make sure you don’t own long-term Treasury bonds or funds that invest in these bonds.
If you do, please get out of these positions before interest rates start to rise in earnest!
Once you’ve cleared these positions out of your account, let’s work on getting your wealth invested in secure dividend-paying stocks that give you income, grow your wealth and leave you with the Rich Retirement you deserve.