A couple of summers ago, my family was vacationing in Woodloch Springs in Hawley, Pennsylvania. It happened to be a particularly hot stretch of summer weather. It was stifling and they had to bring out cold cloths to the golfers to prevent them from being overwhelmed by the heat. This allowed me to have yet another excuse for another sub-par round of golf.
That night as we drove home from dinner, we had an unfortunate experience. As we drove it felt like we were driving over rocks or sticks on the road. In the darkness of the Pennsylvania rural roads, we were unable to determine what was causing the noise. The next day as we spoke with the local hospitality staff at Woodloch, we were informed that those were frogs that we were running over. It seems that the frogs move onto the road in an attempt to get a cooler place to rest.
It seems the frogs could not bear staying any longer in the heat of forest and grass and, in an attempt to be more comfortable, moved onto the cooler pavement. However, they did not understand the risk they were taking by moving onto the drivable surface. They let their uncomfortable state drive their actions without fully understanding the ramifications.
I could not help but relate this story to those who withdrew money from stock mutual funds during the recent stock market downturns and placed their money in bonds or bond mutual funds.
Investors have pulled more than $125 billion out of equity-based funds this year while putting more than $95 billion into bond funds, according to Bank of America Merrill Lynch. Most of the individuals who exited likely did so because of the volatility in stocks and, in their minds, to a safer and more comfortable location for their money in bonds.
But, as many investors may soon find out – like the frogs – that this new location has a lot more risk than they anticipated.
As everyone awaits when the Federal Reserve may tighten its monetary policy, many investors have missed that short-term rates have already started to increase over the last several months. Since the beginning of 2015, the yield on the 2 Year U.S. Treasury note has nearly doubled from 0.45% in January 2015 to almost 0.90% as of November 18, 2015. The yield on the 1 Year U.S. Treasury note has more than tripled , from 0.15% to more than 0.50% over the same period.
Investors should understand the risk associated with the various asset classes and work to determine which asset allocation they need to deliver the returns necessary for them to live a dignified and independent retirement. They should work with an experienced advisor to help them maintain the plan and asset class exposures through normal market cycles. The key to investing is to avoid making big changes to the plan without fully understanding the risks associated with doing so. This will help them not be subjected to the same fate as the unsuspecting frogs.
So whether the Federal Reserve raises the interest rates this month or not, investors should prepare for the possibility of continued interest rate increases in the market place which is ultimately more important for investors.
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