It’s shocking and dismaying to see how professionals in the financial industry constantly get the bond market wrong. Mind you, professionals, not amateurs.
They make up well over 80% of the market so they should know better. And the media, who discuss bonds, are usually in error, when reporting about them.
At the first sign of economic problems, there is talk about corporate defaults and the effect on the bond market. How bond prices are bound to fall because of the risk of possible defaults. And with that talk, the bond market weakens and prices do fall.
But remember: The possibility of default is very quickly factored into bond prices. And the lower the price, the higher the yield, in a direct relationship.
Take high yield corporate bonds, called “junk” for an unfortunate reason having to do with lower ratings. The fact they have lower ratings is compensated by higher yields. If you buy them in a fully diversified, low-cost mutual fund or ETF, and you reinvest dividends, you have factored in much risk.
If the default rates of the holdings were to rise to an unusual high from lower level, the higher yields more than make up for the risk. Yet, all the media will discuss is the risk of default and not the built-in compensation.
Moreover, the media will NEVER discuss how you can avoid that loss, along with any inflation hit, with proper use of bond duration.
This is possible with low-cost mutual funds and use of dividend reinvestment. The media, instead, waste time with superfluous discussions on such instruments as TIPS which are expensive and not really needed. ( See the Earl J Weinreb NewsHole® comments.)
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