The End of Free Money

Smart Money ^ | 18 Jun 2012 | ELIZABETH O'BRIEN

[shove_it]

Regardless of whether the Fed ends its bond-buying program this summer, experts say, investors need to prepare for rising rates.

The economy has been wobbly for years now, like a toddler on unsteady legs. And all along, the Federal Reserve has hovered like an anxious parent, extending a hand at the first sign of a stumble. But analysts say the time's coming for the Fed to let the economy walk on its own, and investors should take steps to prepare.

The latest effort by the Fed to encourage borrowing for everything from homes to new businesses -- Operation Twist -- is scheduled to end on June 30 (it came on the heels of three years' worth of other programs). Whether the Fed extends Twist -- a likely possibility, experts are saying -- or starts another round of rate-suppressing moves isn't the point, some experts [cut "experts" to avoid repetition] say. The fact is, the stimulus will eventually end, and when it does, interest rates will rise. The Fed says it intends to keep short-term rates low at least through late 2014, but analysts say there's no guarantee it will wait that long if the U.S. economy improves."By the time investors figure out that rates have gone up, the damage is already done," says James Angel, associate professor of finance at Georgetown University's McDonough School of Business.

In other words, investors should tweak their portfolios now, experts say. Of all bond types, Treasurys perform the worst when interest rates climb. Rising rates typically signal an improving economy; Treasurys do better in tough times, because investors flock to their perceived safety. Most pros recommend that investors reduce their exposure to Treasury bond mutual funds. Those who hold individual Treasurys needn't fret about losing money, but it's likely the interest payments from the bonds won't keep pace with inflation. Investors could swap their Treasury fund for a floating-rate bond fund, whose payments get reset upward, along with interest rates, or move into high-yield corporate bonds, whose prices are not nearly as affected when the Fed raises rates (see "Corporate Bonds or Treasurys?"). Other advisers are going a step further and recommending that clients reduce their exposure to bonds, period. Deborah DeMatteo, an adviser in Goshen, N.Y., says investors should now consider trimming their allocation by as much as 10 percentage points.

The Fed's withdrawal from the bond market could spark some volatility in both stocks and bonds, experts say. DeMatteo recommends using stock market dips as a buying opportunity. Despite the short-term uncertainty, there will be a silver lining when Federal Reserve Chairman Ben Bernanke withdraws his support: "If we see him step away, I would feel the economy is really improving," DeMatteo says. And those next-to-nothing yields on savings accounts? They'll rise along with interest rates.

[snowsislander]

They'll rise along with interest rates.

The Obamaites are pushing Japan to go into the markets to buy our debt as part of their currency intervention regime; if this happens, rates are still going to stay low.

In general, it is very unlikely that we will see any substantial rise in rates. It would be economic suicide with the vast amount of short-term debt that the Kenyan Clown has amassed.