A Blast From the Past

Posted: Jul 08, 2014 12:01 AM
A Blast From the Past

Most recently we’ve learned that the Federal Reserve has discussed “Gating” bond funds. Apparently, in their quest to keep the persona of American wealth and recovery alive and well, they are suggesting that the stock market and not the bond market is the place to be for everyone. Unfortunately or fortunately everyone doesn’t buy that thinking. Thus, the typical scare tactic, which could turn into reality, is being deployed by the Federal Reserve.

Rates will eventually rise they suggest. You will lose your principle. When interest rates go up bond prices go down. There could be a “Run” on the bond funds which could force delays or even refusals of the return of your principle. In addition, the Fed mentions a penalty for those getting out of their long term investments sooner rather than later. All of the prior leads the sensible thinking individual to the conclusion that to avoid all of these problems one should exit bond funds NOW.

But where to go with one’s money?

The Fed, of course, has the answer, dabble in the stock market and avoid all of the other hassles. More important riches are available and almost guaranteed (?) to everyone, everyday at 9:30 eastern standard time at a place called the New York Stock Exchange.

There is, however, another way for the bond investor to eliminate both the potential “Gating” risk and the interest rate risk without speculating in the New York casino.

The strategy is to buy individual issues such as treasuries and investment grade corporates. You then ladder them over a period of time. Depending on the money available, they could be done semi-annually, annually, or even over several years.

If interest rates rise as many believe fresh maturing principle would be rolled over at higher rates. These benefits are unavailable to a bond fund holder.

Single issues, unlike bond funds, have a maturity date thus removing the falling principle problem if held to maturity. In addition, you are not comingled with other investors thus the removal of the “Gating” potential.

Buying different maturity CDs and even treasuries was a successful strategy in the past, as interest rates were falling, to lock in yields and not be subject to the interest rate risk. Now it seems the same strategy could be successful in a rising rate environment to lock in liquidity and not be subject to the same interest rate risk.

It is possible that laddering's time has come again?