Why do we have our Ten Year Rule? According to Ibbotson’s Yearbook, over a 10-year holding period, stocks outperform any other asset class 83% of the time. If you look at a 20-year holding period, stocks outperform 98.5% of the time. However, when you get down to a five-year holding period, stocks only outperform 77% of the time, and for a one-year period stocks outperform 63% of the time. We find 10 years to be an acceptable balance that will still allow us to achieve the growth we seek. If you don’t need the money, we recommend taking a long-term view of your investments.
Now, if you have a five-year bond and interest rates rise 1%, the value of your bond drops by nearly 5%. If interest rates increase 2%, the value of your bond drops a little more than 9%, and if interest rates increase by 3%, the value drops 13.3%. But why do bond prices and interest rates work opposite of each other? Let’s say you have a $1,000 bond that gives you $1 every year. In five years, you will get your $1,000 back. But then next year, someone else is offering a five-year $1,000 bond that gives you $2 every year. If you need to sell your bond, you will have to sell it for less than what a new bond is selling for because it yields less.
The main concern now is how far out on the yield curve we can go if interest rates are going to rise. While we have been wrong on interest rates rising for five years, we still recommend buying bonds in the three to five year range, and holding them to maturity. When the bond matures, you should be able to reinvest your cash at a higher rate. When you hold a U.S. Treasury bond to maturity, you know what you’ve paid for the bond; you know what you’ll get at the end, and you know your coupon amount. It is a contract that is as close to a guaranteed rate of return as you can get. You generally can weather the interest rate risk in the meantime.
Still, many investors are unwilling to buy short-term bonds yielding 1.6% when a Pimco bond fund can yield 8%. They feel the bond fund is safe; however, as soon as interest rates increase, the value of those underlying bonds will decrease dramatically also lowering the NAV of the fund. Because a bond fund has no maturity date, you don’t know what the value will be when you need to sell it.
Can you afford to stay out of the market? If you invested $1 from 1926 to 2013 and you missed the 40 best months of market performance, your investment would be worth $26.95. If you held Treasury bills during that entire time, your investment would be worth $20.58. However, if you remained fully invested in stocks for the 1,056 months, your investment would be worth $4,676.88.
We believe it is impossible to time the market; therefore, we believe if you do not need the money within 10 years, a long-term view is your best option for growth.
If you have questions regarding your financial situation the experts at Henssler Financial will be glad to help: