Worried Investors Switching To Bonds

San Francisco Chronicle, Sunday August 4, 2002

Many investors buffeted by the stock market’s tempestuous waves are seeking a safe haven for their money. As a result, bonds — derided during the boom times as a lackluster investment — are experiencing a surge in popularity. Laurie Vaughan of Novato is among those who switched from stocks to bonds. She watched $50,000 — more than she makes in a year — disappear from her 401(k) account during Wall Street’s recent meltdown.

“I just couldn’t take it any more,” she said. “My goal at this point is to cut my losses.”

Two weeks ago, Vaughan, a customer service representative at a bank, switched half of her retirement account out of stocks and into a bond fund that had had a positive return for the past three years, even though she knows that prior performance is not an indicator of future results.

“I can afford (to make) 3 percent,” she said. “I can’t afford negative 10 percent.”

In June, investors pulled $13.8 billion out of stock funds, while bond funds took in $18 billion, according to Lipper Inc., a mutual fund research firm. By contrast, in May, investors put roughly equal amounts into stock and bond funds: $10.2 billion into stock funds and $9.8 billion into bond funds. In March 2000, just before the bubble burst on Wall Street, the trend was sharply reversed, with $35 billion poured into stock funds and $8 billion pulled out of bond funds.

“People are moving toward comfort once again,” said Don Cassidy, senior analyst with Lipper in Denver. “Comfort 28 months ago was being totally invested, probably on margin, in tech stocks and funds. Now they’re moving toward (bonds as) something that seems safer.” July numbers aren’t yet available, but Cassidy expects the movement away from stocks and toward bonds will accelerate.

But bonds aren’t a risk-free investment.

“People have to realize: While they’re getting more safety because the fluctuations in the value of their investment aren’t going to be as wild as they could be in the stock market, bonds still are subject to price fluctuations,” said Joyce Franklin, principal of financial-planning firm Franklin Financial Advisors in San Francisco.

Especially now, when interest rates are at historic lows, there’s a good chance that bonds will lose value in the future. That’s because bonds, which pay interest based on the rate when they were issued, are worth less when interest rates rise. (Conversely, they’re worth more when interest rates drop.)

“Let’s say you buy a new bond at today’s prevailing interest rate,” Franklin said. “If interest rates rise 0.5 percent next year, you’re holding a bond that’s paying last year’s interest. When interest rates go up, your bonds are worth less.”

Corporate bonds are in the same pickle as the stock market. Corporations in precarious financial straits get their bond ratings downgraded.

Like all financial planners, Franklin says people must determine their portfolio mix based on a variety of factors: their age, assets and income, and how risk-adverse they are. She doesn’t think the market’s fluctuations should play a role.

She’s been hearing from clients wondering if they should switch to the safety of bonds.

“I still lead them back to the decision they made two years ago when they decided on their portfolio,” she said. “If it was a good idea to invest in the bonds two years ago, keep those bonds today. If it was a good idea to invest in stocks two years ago, it’s probably an even better time now.” Financial planner Bruce Dzieza, president of Willow Creek Financial Services in San Rafael, thinks this is the worst time to switch to bonds. “Bonds are at historic lows now; it’s like going into the stock market a couple of years ago while (the Dow) was at 11,000,” he said. But if someone really wants to switch to bonds, he thinks picking a bonds fund, which is what Vaughan did, is the way to go.

“A bond fund offers a low-cost way of getting diversification,” he said. “If you put $25,00 into one bond, there’s no diversification, very little liquidity.”

So far this year, the average taxable bond fund has had a 3.5 percent return, while the average domestic stock fund has declined 17.6 percent. “A lot of people say, ‘I can’t stand the pain’ without looking at what they really need,” Dzieza said. “They don’t understand that inflation is your worst enemy. If you lock in a 15-year government bond at 4 percent, you’ll have a problem down the line with inflation.”

One way to avoid that problem is to consider the new kinds of bonds called Treasury Inflation Protected Securities, which were first issued in the mid- ’90s and are tied to a government inflation index. Vaughan, who made the switch, says she knows that emotion played a big part in her decision.

“All of a sudden you’re sitting there saying, ‘How the heck am I going to retire?’ she said. “Social Security sends me a statement that I’ll get X amount. OK, that’ll pay the mortgage. What about my PG&E (bill)? What about food? Do I rent my place out and get a tent?”

Still, Vaughan, who describes herself as a “leading-edge Boomer,” is grateful that she’s better off than many. “I feel really bad for those who are retiring now,” she said.

Five years ago, she borrowed money from her 401(k) for the down payment on a condo, which has now appreciated 50 percent. “That’s the best-performing asset I have,” she said.

And during the boom times, her 401(k) did well.

“The rising tide floated my boat, too,” she said. “My boat went up; my boat right now I feel is on the rocks. How do you hunker down in this storm?”

E-mail Carolyn Said at csaid@sfchronicle.com.
©2002 San Francisco Chronicle.