Tuesday, September 25, 2012

Americans Holding Bonds: Sitting On A Camouflage Time Bomb

The following chart shows the mutual fund inflows out of stocks (red line) and into bonds (blue line). This shows that the average American through their 401k has been piling into bonds at an almost unrelenting rate over the past four years.


In a FINRA National Financial Capability Study, average Americans were asked the following question:

If interest rates rise, what will typically happen to bond prices?

The correct answer is "prices will fall." What percentage of respondents knew the answer?

21%

Americans right now are piling into bond funds at their highest price in history. It is the exact equivalent of piling into stocks in 2000 and real estate in 2005. In all bubbles in the past Americans knew subconsciously the danger they took in purchasing an investment. It was clearly obvious that if prices fell in either stocks or real estate then they would lose money. They just disregarded the notion because they were caught up in the manic psychology.

This time it goes even beyond that. Not only are investors piling into bonds at the peak of the mania, but they don't even know that prices can fall. They think of a bond as the equivalent of cash.

Ask some people you know what they think would happen to a bond they hold if rates were to double. I bet almost all of them have no idea.

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