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Last week, I showed you how to spot potential stock market danger (Scroll down to see). This week, I’ll cover when bonds are really risky since most investors have at least some of their money allocated to bonds. One of the first things you learn about investing is that bonds are safer than stocks. While this can be true, especially with U.S. Treasuries, there are times when the value of your bonds can drop, just like the stock market. Most investors don’t realize that their bonds can drop 50% from what they paid for them!
Here’s the lowdown on bonds…
Part III: Bonds and Interest Rate Basics
Bonds move in relation to several things, but most importantly interest rates. When you buy a bond, you get paid the interest that is stated on that bond. I like to say it’s like a bank in that you are lending money to someone. Then they are going to pay you interest while you are lending that money to them.
Being Aware of Interest Rates
Now, bonds can be short bonds that are only for a few years, or they can be for a long time, such as 20 to 30 years. The further they go out, the more they are going to change in value, due to the interest rates. Long-term bonds will move down in value when interest rates go up. This means that noticing where we are in the interest rate cycle will give insights as to whether your long-term bonds will be more likely to drop soon.
For this reason, you’ll want to pay attention to interest rates. The current interest rate is something that you probably already know. If you have money invested in long term bonds, be prepared for the value to decrease when bonds rise.
Believe it or not, interest rates were as high as about almost twenty percent in the early 1980’s. We have seen unusually low interest rates for many, many years now as I write this. All you need to remember is when interest rates go up, the value of bonds, especially long-term bonds, goes down. When interest rates go down, bond values increase.
Again, this is logical: investors can get a better interest rate on those new bonds since interest rates are higher. This makes the value of the old bonds go down. This would affect you as an individual investor, if you own individual bonds, if you wanted to sell your bonds. Most people, however, own bonds through some sort of bond fund.
A Flight To Safety
One other thing you’ll want to know about bond price fluctuation is that when there is abnormal uncertainty or volatility, the value of Treasury bonds usually increases. This is called a flight to safety. There are other variables to know about bonds that can affect their value, such as quality and type of bond, but interest rates broadly drive long-term bond prices.
It’s easy to stay on top of this risk. While it can be a bit trickier to spot the danger signs with stock market analysis, everyone knows when interest rates are rising.
Watch More on This Here:
Part II: How to Spot Danger Signs in Stock Market Trends
Two weeks ago, I wrote about the importance of paying attention to whether the stock, bond or real estate market is overvalued or cheap, based on history. (Scroll down to see.) This is one of the first things you’ll want to learn about investing so you don’t stash all of your money into a highly overvalued market. While this isn’t an exact science, or an excuse to avoid investing completely due to fear of the unknown, there’s a lot to be said for carefully considering valuation before buying anything, ever.
This core Financial Woman principle applies to stocks, houses, and handbags! As the saying goes, the trend is your friend. For example, if you had bought the Dow Jones stock index in March 2009 with $20,000, and sold in early March 2017, your investment would have grown to about $64,000. (1) If you had bought the Dow index in March 2007, and needed to sell in March 2010, you’d have a different, and very sad story entirely.
Now, I’ll share ways you can see potential stock market danger bubbling just beneath the surface of overvalued markets. Remember, no one can predict the exact top or bottom, but an awareness of long term trends makes it easier to accumulate wealth over time.. The best financial experts have completely different opinions about how long a market trend will last while it’s happening.
Terms you’ll want to know are that a strongly rising market is called a bull market, and a dropping market is called a bear market. You’ll also want to know that when the market drops 10% it’s considered a correction, which happens about every year. (2) When the market drops another 10% for at least 20% or more, it’s considered a bear market.
1. Time Frame
Use time frames to your advantage. By time frames, I simply mean how long a market has been moving in the current direction. For example, if a market is usually up for 6 years on average, and it has been up for 8 years, this is a long time based on history. The same is true for markets going down. Watch my video here where I explain more about this.
While the economy, politics and other factors affect financial market trends more than anything, time frame extremes can be a good signal for paying more attention to your investments.
2. Stock Charts
When I began investing seriously in the early 1990’s, I kept an image of a long-term stock chart on the wall beside my desk as a reminder that the market has always gone up over long time periods. I had a long-term perspective back then. In my fifties, I have a different perspective, and I’ve learned a ton about investing since then.
Take a look at a long-term stock chart for S&P 500 index. If you don’t know about this important stock index, you can learn about it here. Don’t feel intimidated by stock charts; a chart is an easy way to look at the performance of the overall stock market.
There are numerical tools, like the PE ratio, that I also like to consider. I like to look at a nice long-term stock chart, however, for a rock sold historical visual perspective. As the saying goes, a picture is worth a thousand words.
Looking at a weekly chart, every week or two, keeps you in tune with the stock market. It only takes about 5 minutes to take this simple step that reveals so much! You already know that the market constantly goes up and down, but the larger moves display beautifully on a weekly chart.
The Best Thing
The thing that I like most about stock charts is that you can see what the markets have done in the past. You are able to easily see how long it’s been since they were at a peak, or how long it’s been since they had a big drop. As I write this, we are in year eight of a rising bull market, which is the second longest bull market in history.
This fact naturally makes me a little more cautious with stock investing. Note: facts are logical, rather than emotional. Emotional investing is what typically gets us into trouble.
From the chart, you will also easily see the big ups and big downs in the early 2000’s when we had a correction of about 60% in some areas of the stock market. Then, we had 50% corrections in the 2008 period. Ouch! This is obviously what you want to avoid. Somehow seeing these big moves depicted on a chart makes them easier to grasp.
3. Ask What’s Most Likely to Happen?
Again, no one knows where the stock market is headed for sure. For every investing expert that says the bull market will end soon, another investing expert says that the bull market will keep rising. For the most part, these are all smart people who spend their lives trying to figure this stuff out. Keep in mind that there can be a bias by some of these experts to say that the market will keep rising because stock investing is what they do for a living. For the most part, though, investing experts want to be right.
Acknowledging that no one knows for sure where the market is headed takes the pressure off of you as an investor. But then there’s still the concern of losing your money, so here’s what I do. I like to ask myself what’s probable before I invest or stay invested. A market uptrend can last longer than any other bull market before it, making new history.
No one knows for sure, but probabilities can be used to guide you in the right direction when you’re investing your money. The odds are greater that there will be a stock market correction in year eight of a bull market than in year one or two. It doesn’t feel that way, though, because everyone still feels the pain of the bear market.
4. How Much Am I Likely to Gain?
Take a long-term perspective and see how much the market has been up since the last bear market. For example, if stocks have risen 250% during a bull market, ask yourself how much more likely is it to increase in the bull. Ask yourself if that additional 20 or 30% is worth the risk. While this approach may leave some money on the table in the form of investment returns should you choose to bail, it would lower your risk during a major market correction.
5. Consider Your Investing Time Frame
If you’ve ridden the market up 200% over a very long time frame, a drop of 40% feels less detrimental than if you put your money into the market just before a huge drop. That’s because you have a bigger base. It takes so long to recover from those huge drops when you enter the market right before the drop. This reality is why it’s so important to begin investing as early as you can.
If you’re a new but long-term investor with a couple of decades to invest, then you may choose to ride out those ups and downs. If not, and you have nearer term goals, you will want to be more cautious about investing in stocks near the top of the cycle.
6. Staying Realistic
Don’t be caught off guard with market corrections, or sell low and buy high repeatedly. Make an informed decision about what you’re doing, and do it with confidence based on knowledge and facts.
Don’t be shocked when history repeats itself and the value of your retirement account drops 50%. The market will drop again. The only question is when, how much, and will you need your money before it goes back up to where it was before the drop.
If you’ve chosen and prepared to ride the cycle, then you’ll have peace from that decision. You won’t feel panic when the drop happens.
If you don’t want to ride the cycle down, take a look at the percent of your net worth you have in stocks. Knock 30% to 50% off of that amount and see if you can live with it. If not, learn more about how to be prepared for a bear market. Meet with your financial advisor if you have one, and see how your concerns are being addressed. If you don’t work with a financial advisor, you can hire one by the hour, if you feel this is what you should do, but be super careful about who advises you.
7. Have a Big Picture Perspective
Finally, consider the potential tax sting of selling investments with large gains. While you don’t want taxes to be the only reason you stay in a market you’ve deemed seriously overvalued, taxes are a real expense that can reduce your profits if you do sell.
8. Easing Out
If you’ve done the math and see that you can handle your portfolio dropping $50,000, but not $100,000, you can always take a portion of your money out of the market. Investing doesn’t have to be all or none. This goes back to knowing how much money you have, how it’s invested, and the risk that’s involved with each investment.
Either way, do some research first. Be informed. Lead your wealth. Leading without knowledge doesn’t work with anything.
This is where I need to repeat: Nothing in this article is to be construed as financial advice. Do your own research. Or you can hire a registered financial professional. I’m just sharing what I learned from over three decades of investing my own money.
Next time I’ll write about why bond markets drop, and how you can see the danger signs. In the meantime, get the investing basics you’ll want to know here, in my free eBook.
Part I: Taking Advantage of Cycles
Everyone knows that the price you pay for something determines how much money you’ll make when you sell it. Taking advantage of those ups and downs, or cycles that are happening in the market, lowers the price you pay for almost any investment that swings in value. This is one of the first and most important things to learn about investing.
You may have heard, read, or even have been told that long-term investing is so important. You may have heard that you don’t need to worry about how much money you are putting into the market or how much it costs when you do invest in stocks. You may have heard that you just need to be a long-term investor. Though any of these statements are true in many situations, you may not have that long until you need your money. Examples of this are approaching retirement if you’re in your forties or fifties, or college savings for high school students. In these cases, you can’t apply long term investing rules, such as twenty years, to shorter term goals, such as five or ten years.
Importance of Timing
If your investing time frame is near, make sure that you pay attention to the cycles that are happening in the markets. When you are able to capture trends or cycles in the market, you’re able to accumulate wealth faster. There’s no avoiding the reality that if you buy something cheaper, you’re are going to make more money with your investing.
Can you pick the exact tops and bottoms? No. Am I encouraging market timing? No. All I am encouraging you to do is be aware of how a market is priced before jumping into it.
Easing In and Out
As my father used to tell me, it is really hard to pick the exact tops and the bottoms when investing, but if you can just ease in and ease out somewhere near those tops and bottoms, then you will do well. I’ve always remembered that message to this day. Have I always done this? No! The reason is because it took me years of investing to clearly see that the fear near the bottoms makes it super hard to invest near them. And the greed near the tops of markets makes you want to stay in them.
Fear and Greed
Fear and greed are what drive markets. They are what can decimate savings accounts. They can keep you awake at night. If you can bring logic into your mindset when investing, you can improve your results. This is one of the most important things you can learn about investing.
There are three major markets for most investors, stocks, bonds and real estate. There are clues and tools that you can use to gain insights for whether you are buying near the top of the market or near the bottom of the market. These insights can replace emotions with logic. These same insights can be used when buying a home, which is a huge real estate investment. You simply have to know what these signs are, and have the curiosity to keep an eye on them.
Seeing the Signs
You’ll see some of these signs in your daily life without any extra effort beyond choosing to notice them. Once you do, you can choose to be a proactive investor who uses her insights to her advantage when investing. In my next post, I’ll tell you the signs and clues for the stock, bond and real estate market. In the meantime, get curious about whether the markets you’re invested in are cheap or overvalued.
If you’re ready to learn about investing, be sure to grab my free investing basics eBook here.
Sources:
(1) The New Yorker
(2) Tony Robbins