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A Quick Take On Bonds

Question.  ''How do changing interest rates affect bonds and stocks and why does the threat of a rate increase slow the market?''

Answer.  A rise in interest rates is, in general, bad news for stocks. Interest rates often rise when investors grow concerned that inflation will rise. Why? Because higher inflation reduces the value of a company's future earnings and stock prices are often based on companies' projected future earnings.

Rising interest rates are also bad news for stocks for a different reason: As rates rise, the yield on bonds becomes more attractive.

Also companies' borrowing costs rise when interest rates climb.

EXAMPLE: If bonds yield only 4%, investors will likely seek out stocks, figuring they can earn at least 8-15% if invested in the market. But if interest rates rise to 8%, investors realize they can garner nearly the same upside while minimizing risk. That 8% bond yield is virtually guaranteed; stocks come with no such promise.

Bond prices move in the opposite direction of their yield. So if interest rates are rising, bond prices will drop.

Much of the recent strength in the stock markets is attributable to an attractive interest rate. As inflation has receded, investors have poured money out of 'safe' bonds into stocks.

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Show Me The Money

Make Your Savings Earn More For You

According to a study, Americans keep more than $1 trillion in low-interest rate savings accounts, often for convenience and a desire for easy access to their cash. 

But by shifting that money into safe, higher-yielding accounts, you could reap $30 billion to $50 billion in additional interest yearly, says the Consumer Federation of America and Providian Financial Corp. that commissioned the study. 

Low-yielding savings accounts that are earning on average 2.1 percent are widely held by consumers, no matter the age, income or education, the groups said. But Americans 65 and older may be losing out more than other age groups because they are more likely to hold accounts with $25,000 or more. 

One of the dangers is in keeping money this way is that for the things they want in life you come up short. The other danger is that, failing to see any kind of satisfying return on your money, just might not excite you about saving. In other words if you are not growing your money, then why should you save?

How can we put our money in proper places? 

Here are several options: 

1) Money market mutual funds, now paying 5.5 percent to 6.5 percent in taxable funds. They invest in Treasury bills, commercial paper and other short-term obligations, and though not FDIC insured, are widely considered safe. One can write checks, although many funds require a check to be a minimum amount.

Top 10 Things to Know About Bonds

1. Bonds are fancy IOUs

Companies and governments issue bonds to fund their day-to-day operations or to finance specific projects. When you buy a bond, you are loaning your money for a certain period of time to the issuer, be it General Electric or Uncle Sam. In return, bond holders get back the loan amount plus interest payments.

2. Stocks do not always outperform bonds.

It is only in the post-World War II era that stocks so widely outpaced bonds in the total-return derby. Stock and bond returns were about even from about 1870 to 1940. And, of course, bonds were well in front in 2000, 2001 and 2002 before stocks once again took charge in 2003.

3. You can lose money in bonds.

Bonds are not turbo-charged CDs. Though their life span and interest payments are fixed -- thus the term "fixed-income" investments -- their returns are not.