Today: Safe = Dangerous.

The bond market today feels like the housing market in 2007.

People might get hurt by what they have been told is safe.

Why? Put simply: interest rates have started rising, and this has already begun to wreak havoc on bond markets. As a result people who own fixed income investments - often the older among us - have already begun to lose money and will likely lose a lot more.

There are worse things than losing money, but for people who have worked hard for their whole lives, losing money while in retirement hurts. Especially when it comes by surprise.

Why is this happening?

Interest Rates fell over the last five years as the Fed sought to stimulate economic growth.

Fortunately, this worked. The economy is recovering and markets are at all-time highs.

However, now that the economy is showing broad signs of strength, it is becoming clear that record low interest rates won’t last forever.

Rising rates = falling bonds.

Bond math is unintuitive. The nuts and bolts aren’t that complicated, but for some reason ideas like “duration” and the price impact of rising interest rates just doesn’t stick in the brain.

The punch line is easy: when rates go up, prices of bonds go down. The longer the length of the bond (or “duration”) the more it falls.

This post (The Long and Short of Duration) by Invesco does a good job summarizing the details of “duration” and why it matters.

The impact of rising rates was clear in May, when bond markets got crushed. The NYTimes wrote it up here:

Vanguard’s Extended Duration Treasury Index fund was down more than 6 percent…Annaly Capital Management…fell 8.7 percent, and an iShares mortgage exchange-traded fund lost 10.4 percent. Pimco’s Corporate Opportunity Fund…lost nearly 13.4 percent.

These losses all occured in one month. Pause on that. Some of these large bond funds were down double digits. In May.

This happened because the 10-year treasury yield rose 50 basis points. Or in English: the markets started to anticipate that interest rates will not remain low forever.

So imagine what will happen when The Fed actually starts raising rates later this year or next year.

Falling bond prices = People lose money who thought they were safe.

Most investing advice states that if you are older and want less risk, you should take out money of the equity markets and put it into bonds.

The adage of shifting money from stocks to bonds as one gets older is treated as common sense. It is also embedded in one of the fastest growing areas of the financial markets - Target Date Retirement Funds. From the Department of Labor’s website defining these funds:

As the target retirement date approaches (and often continuing after the target date), the fund’s asset allocation shifts to include a higher proportion of more conservative investments, like bonds and cash instruments, which generally are less volatile and carry less investment risk than stocks.

There are differences between the ways these funds work, and fortunately lots of people don’t follow these rules of thumb. But many people do.

This means people who think they are avoiding risk hold a lot of fixed income investments, and many of them might not even realize it.

And this is scary.

So what should we do about it?

This is the hard part. I’m really not sure. Fortunately, people are beginning to discuss this issue, and hopefully, it will be some time before the Fed begins to really raise interest rates.

Who knows, maybe the economy will lose steam and rates won’t rise.

However, I believe that as people continue to rotate out of bonds and into equities, rates are going to begin to rise regardless of when the Fed actually acts. My guess is this is part of what happened in May. I could be wrong about this, but it seems logical.

In other words, I think there is a good chance that what we began to see in May will continue regardless of when the Fed raises rates.

I wish I had a silver bullet for how to prevent the losses that seem to be emerging on the horizon for those who least expect it.

Maybe awareness is the best outcome.

I can’t help but think back to when we were watching the housing market begin to decline in 2007. It was like a watching a train wreck in slow motion that too many people ignored until it was too late. I really hope things end differently this time around.