Podcast Transcript: Fran Kinniry
Here's a transcript of the conversation Mike Sante, managing editor of Interest.com, had with Vanguard Group investment strategist Fran Kinniry.
Mike Sante: Hi, this is Mike Sante at Interest.com, and we are talking today with Fran Kinniry, a prominent investment strategist at the Vanguard Group about bond prices and what might happen to them in the next couple of years.
Fran, what should someone who holds bonds, probably in the IRA or 401(k), be thinking these days when we know that interest rates are at record lows and, when interest rates are very low, then bond prices tend to be very high?
Fran Kinniry: Yes. I think what the low level of interest rates tell us, factually what they tell us, is that the forward-looking returns are going to be lower than they have been over the last 10, 20, 30 years. For example, the last 30 years the average yield on bonds was 6 or 7%. Today they are around 2%, so expectations forward looking have to be very close to the yield, which is around 2%.
Mike Sante: A lot of Interest.com readers have bonds in their 401(k) or their IRAs. Frequently through target date funds. I mean that is a very popular way to invest in 401(k) in particular. And especially, and of course the closer you are to the maturity of that target date fund, the more bonds you have. So if you have a target date fund in your 401(k) that has a maturity date of, say, 2013 or anytime in the next five or six years, you could easily have 40% of your money tied up in bonds and maybe even as much as half of your money in bonds. So when we hear the idea that, "Oh my gosh, bond prices are likely to fall when interest rates go up," that raises a big question for us. What should we do? How worried should we be?
Fran Kinniry: Yes. I do not think anyone out there should be worried about nearing retirement or being in retirement and having a lot of bonds. Bonds have a much, much lower risk profile, even if interest rates go up relative to other asset classes such as the stock market, commodities.
So while interest rates may rise at some point, and let us be clear, we have been talking rising interest rates now for 12 years, which has not happened. But if they do rise, investors could experience small losses in their bond funds, but the losses will be significantly smaller than other asset classes that are out there.
Mike Sante: But should, for example, someone who has a target date fund that is a 2015, say, and that reflects sort of that they are getting toward, they are in the 60s and they are getting toward retirement, would it make sense for them to perhaps move that money to, say, a target date fund of, say, 2020 or 2025 and reduce their exposure to bonds in that way? Because those kinds of funds would have perhaps a 25 or 30% bond exposure?
Fran Kinniry: Absolutely not. What we do know is that by doing that you are taking on more equity risk. And hopefully the global financial crisis of 2008 and 2009 where the stockmarket dropped 55%, the internet tech bubble in 2000 where the stockmarket dropped 40%. The stockmarket has had multiple, multiple 20% pullbacks in its history.
The bond market has never even had a double digit negative loss. So once again, I could not be more clear, investors nearing retirement or in retirement, bonds are the best asset class for that investor.
Mike Sante: We may not have seen that in the past but we have been experiencing an extraordinary intervention in the market by the Fed that we have not seen before. They have been driving interest rates down way lower than we have ever seen before. They have been keeping them there way longer than we have ever seen them hold the rates down before. It makes you nervous about what happens with the Fed starts to ease its policies and allows interest rates to start going up again. How should we view that?
Fran Kinniry: Yes. The Fed really has a lot of control over money markets and certificate of deposit, so very short maturity inside of one year. But longer bonds, the duration bonds, three-, five-, 10-year bonds are not nearly as influenced as much by Fed policy. And from that standpoint, we have seen the Fed raise interest rates coming out of the tech bubble and coming out of the global financial crisis, and duration bonds actually did quite well.
Mike Sante: So even if we hear that the Federal Reserve is going to stop buying Treasury bills and Treasury bonds sometime this fall, say, we should not be worried about that.
Fran Kinniry: Again, I would not link that to the concern. What tends to hurt bonds is a very strong economy, a very strong employment market, and so when you see the economy heating up, and you see the employment market heating up, and you see capacity being constrained, that is when you see inflationary signs. So the bond market is really going to take its cue from inflationary signs, much less as to what the Fed is doing, which really impacts the front end of the interest rate curve.
Mike Sante: All right. Thank you very much. We have been talking to Fran Kinniry, a CFA and a principal in Vanguard’s Investment Strategy Group. Thank you very much.
Fran Kinniry: Thank you very much for the time. Bye-bye.
Mike Sante: You bet. Bye-bye.