NEW YORK — Investors who are getting beaten up in the stock market often look to bonds as a safe place to stash their money. But they need to make their moves deliberately, not out of panic, or they can end up losing money rather than stabilizing a portfolio.
Common mistakes investors are likely to make in the current climate include moving too quickly, and not paying enough attention to the kinds of bonds they're buying.
The idea of moving toward safety is more complex these days because some of the chaos in the financial markets stems from bonds — including those tied to risky mortgages that have since gone into default. The multiplication in recent years of the types of fixed-income investments means that not all bonds are the same; while the government provides safe investments, there are also bonds that bring in higher returns but take more chances to do so.
Rich Berg, chief executive and co-founder of Performance Trust Capital Partners, said investors need to know what they're getting into. If they're lured by exotic names like collateralized debt obligations or collateralized loan obligations, they need to understand that the more complex the investment, they more likely to are to spell trouble.
"These aren't mom and dad's bonds," he said. "When people think they're going into bonds for safety they might actually be exacerbating their risk."
He said investors also need to consider how much they're willing to sacrifice in investment returns in order to safeguard their money by putting it into bonds. That's important these days because interest rates are low, limiting what many bonds pay.
"Right now, if people are OK with a long-term return of between 3 and 4 percent, go put your money in government bonds. But don't expect 6 to 8. It can't happen," he said.
They might want to consider that professional investors have been stashing cash into 3-month Treasury bills, sometimes earning almost nothing, but secure knowing that their principal will remain intact. The average investor doesn't need to look for such short-term investments, but that kind of safety is what makes government debt of all maturities so attractive.
Stuart Ritter, an assistant vice president and certified financial planner at T. Rowe Price Associates Inc., said investors who do want to make money shouldn't simply scout around for the highest returns because market forces can shift what is in favor — and those returns could then head south.
"If you start making investment decisions based on what happened in the recent past and try to forecast the near future you're no longer investing, you're fortune-telling," he said.
And he warned that investors who move too much money into bonds might risk earning so little they can't keep pace with inflation.
"As people go to something that is 'safe' from short-term volatility, by definition they are in something that gives them much higher exposure to the risks of inflation," he said.
Consider an example of how two investors with $1 million portfolios at the start of 2001 would have fared by taking two different paths, according to T. Rowe Price research.
The first investor who panicked and shifted from stocks to cash during the downturn that followed the tech-stock boom and the Sept. 11, 2001, terror attacks would have ended up five years later with about $700,000, while the investor who stayed in stocks and rode the ups and downs would have come out with about $1.25 million.
"You didn't see the decline coming, you're not likely to see any recovery that's to come. The only way to participate in the recovery is to stay in," Ritter said.
But before putting money into bonds or bond funds, investors should remember, again, that those paying higher yields are probably taking on more risk. And a conservative approach can be in order for investors who will soon need money.