Even as the biggest losses since June hit the bond market last week, small investors continued to sock away billions of dollars in long-term bonds, especially risky zero-coupon issues, according to data gathered for Money magazine's Small Investor Index.
Bond prices fell by half a percentage point, costing the average individual investor $16, after the Bush administration proposed cutting taxes to stimulate the economy. Investors fear the cuts would further swell the budget deficit, thereby driving up interest rates.Nonetheless, small investors are still rushing into zero-coupon bonds, which pay no cash interest but are sold at deep discounts to the amounts they are worth at maturity. The brokerage Advest reports that it has sold $1.5 billion of zeros so far this year, compared with $1.2 billion for all of 1990. And Fidelity's discount brokerage arm has been selling $7 million of zeros a day, up 15 percent from last year's pace.
Small investors are enthusiastic about these bonds, because they have turned in profits of as much as 17 percent as interest rates have plummeted over the past four months. Bond analysts warn, however, that buying zeros now, when interest rates may be close to a bottom, could be very risky.
"Chances are at least fifty-fifty that rates will be higher a year from now as the economy recovers," says Fred Quirsfeld, manager of the IDS Bond Fund in Minneapolis. In that case, he adds, if you buy a zero yielding 8 percent today and rates rise half a point to 8.5 percent, your bond's price could drop by as much as 15 percent, giving you a loss if you had to sell before maturity.