Money Talks: Calculating losses
As we matriculate into the fall season here in paradise, certainly one of the last things that investors have had concern for would be calculating losses. The three major asset classes of debt, equity and property, i.e. bonds, stocks and real estate, have gone nearly a decade since the last meaningful loses occurred. The concept of calculating or even comprehending losses may be lost on many retired investors.
The real estate boom/bust of 2006 now seems like a faint memory while the current level of pricing has approached record highs. Calculating losses seems all but lost for many as the specter of rising interest rates come to the forefront. Speaking of interest rates, the bond market has likewise enjoyed a meteoric run unprecedented in modern history.
Although the last 10 years have yielded virtually zero losses for the bond market, we can easily establish that based on our empirical knowledge, or knowledge through experience, that rising rates will eventually have a negative impact on bond values. “Investing 101” reminds us that bond prices move inversely with interest rates. Similar to a see-saw on the playground, when rates move up, the values of bonds goes down. The key here is to understand the particulars of calculating potential bond losses. The premise is based on the length of maturity of the individual bonds. The rule of thumb is that the longer the maturity of the bond, the more fluctuation in values they will experience.
For instance, US treasuries are segregated by maturity. A U.S. treasury bill matures in less than 12 months while a U.S. Treasury Note has maturity dates between two and 10 years. The Treasury Bonds will mature anywhere from 10 to 30 years. Many mutual funds own debt, or bonds, inside the portfolio often unknown to the investor. As rates move up, the values of bonds move down, only on this case, the farther out the maturity the more fluctuation in values. In a rising rate environment, T-bonds will lose more value than T-bills due to length of maturity dates.
Unfortunately, as rates continue to rise, there will be a slow erosion of bond values in the form of losses including individual bonds as well as mutual funds with bond holdings. As far as the stock market is concerned, certainly the calculation of losses can be digested during our daily overdose of financial information available to investor’s 24-hours a day. While most simply check their monthly statements, clearly there have been minimal losses to calculate during the now 8 year bull market. Similar to the bond market, rising rates, at some point, will also have a negative impact on the stock markets in the form of rising costs of conducting business. These losses, when they finally arrive, will be quite easy to track and calculate.
Speaking of calculating losses, we have crossed into not only uncharted territory with stocks but at the same time, may be crossing into the eventual side effect of a thriving market. The unfortunate issue here is twofold; first, if the economy and financial markets are as strong as many believe, The Fed will have no choice but to continue to raise rates. However, on the flip side, if the economy and markets are not strong enough to stand on their own, this may slow the rate increases while at the same time may generate losses in the form of a softening economy unable to maintain the current levels. At some point, this will come to fruition under one of these two manifestations.
For now, while investors sit and watch the markets grow to the sky, now may be a good time to embrace the ability of various alternative asset classes to safeguard the recent market gains. For many, the insured index portfolio has become a popular avenue as they can capture a percentage of the markets return while insuring against market based losses. The ability to avoid losses in bad times while capturing even a percentage of markets gain in good times can lead to the life of a SWAN, Sleep Well At Night.
William F. Hague is a managing partner of Hague Wealth Management; 239-389-1999 or WFHague@earthlink.net. The opinions and observations stated above are those of the columnist.