Many experts believe we are on the cusp of a "great rotation" out of bonds and into other investments (primarily stocks). The bond market, due to falling interest rates, has been a good place to be ever since Paul Volcker subdued inflation by raising the Fed Funds rate to an astounding 20% back in the early 1980s.
The current Fed Funds rate, which is somewhere between 0% and 1/4%, is at its lowest level ever. At some point in time, the Fed will begin to raise the Fed Funds rate as the economy becomes stronger. As interest rates begin to rise, a bear market in bonds will take hold since, as interest rates increase, market prices or values decrease. Experts such as PIMCO fund manager Bill Gross believe the Fed should begin to remove quantitative easing and start raising interest rates sooner rather than later.
Rising interest rates, or the scaling down of the Fed's quantitative easing program (commonly referred to now as "tapering"), could incent bond fund holders to liquidate their holdings and look for other more promising investments. It is thought that much of the funds coming out of bonds could find their way into stocks.
The great rotation is just a theory which may or may not turn out to be accurate. There is no guarantee that investors will choose to move their money in the way that experts believe. In support of a great rotation scenario, many market-watchers state that there are trillions of dollars sitting in short-term fixed asset investments that were liquidated from the equity markets during the market crash in 2008-09. Many of these investors have never re-allocated a portion of their balance to the equity markets. It is possible that rising interest rates could cause these investors to consider a more balanced approach to their portfolios, providing fuel for an increase in equity markets.
Regardless of whether a great rotation occurs, most investors will benefit from establishing an investment plan and sticking to it, ignoring short term market fluctuations. Trying to time markets almost never works. Investors should be thinking about the long-term and shouldn't be concerned about short term market fluctuations unless they are less than five years from the date they will need their funds (for retirement, to pay for college expenses, etc.).
Contributing Editor Robert C. Lawton is President of Lawton Retirement Plan Consultants, LLC a Registered Investment Advisory firm helping retirement plan sponsors with their investment, fiduciary, employee education and compliance responsibilities. Mr. Lawton has over 25 years of experience working with corporations on their retirement plans and is a Chartered Retirement Plan Specialist (CRPS) and Accredited Investment Fiduciary (AIF). He may be contacted at firstname.lastname@example.org or 414.828.4015.
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