Over the last several years, many brokers/financial advisors have been recommending bond and bond funds to their clients without properly informing them of the risks they entail.
Investors have purchased in excess of $1.1 trillion bond funds since March 2009, according to the Investment Company Institute, the funds’ trade group. Currently, $3.4 trillion sits in bond funds, or about 26% of the industry’s $13 trillion in assets.
While interest rates have been at historically low levels and bond funds have done well, as rates increase, the bond values decline. Upon information and belief, many brokers have been touting bonds as safe investments.
Additionally, the longer the maturity of the bond, the greater the risk. For example, if a broker recommended his client(s) purchase a portfolio of long-term bonds instead of short-term bonds, there is a substantially greater risk of loss.
The general rule of thumb is that for every 1 percentage point increase in rates, bonds will lose the equivalent of its duration in price. For example, a 5-year bond would lose 5%. For a bond that comes due in 2055, it’s more like a 40% loss.
According to The Securities Law Firm of Menzer & Hill, P.A., many brokers are purchasing long-term bond funds that have maturities that exceed the life expectancy of the investor. Therefore, if rates continue to increase, the purchaser risks never receiving back their full investment.
Brokerage Firms and their advisors may be held liable for client losses if they failed to disclose all the risks related to the investments they recommend to their customers.