Steer Clear of the Safety Bubble

There are two connected objectives in the world of investing: Make a good amount of money on the way up, and don’t lose too much on the way down. Most of the time, investors lean heavily on the first and nearly ignore the second. That has led legendary investor Warren Buffett to flip the priorities: “Rule No. 1 is never lose money. Rule No. 2 is never forget Rule No. 1.” In the wake of the 2008—2009 financial crisis, however, we’ve come to a strange place, in my opinion: Investors have become so consumed with safety, with not losing money, that they’ve created a “safety bubble.”

A bubble occurs when an asset’s price inflates to such a high, unsustainable level that it eventually falls–sharply. Most bubbles are speculative ways to supposedly get rich quick while expending little effort. One example is the Internet bubble that jump-started the new millennium, only to spectacularly burst, earning the label “dot bomb.”

The safety bubble is not, at its core, based on greed, but fear. Investors want to avoid losses like those of the 2008—2009 bear market. They have developed a preference for assets traditionally associated with low risk. But as dollars have poured into these areas, their prices have skyrocketed to levels that I think are likely to tumble.

For instance, the ultimate “sky is falling” asset is gold. From March 1987 to May 2005, gold had a return of zero. From there, starting at the $420 per ounce price, it more than doubled by early 2008 and then doubled again to more than $1,700 by August 2011–peaking at roughly $1,900 the next month. It now trades just below $1,600. Intellectually, gold is seen as valuable if the modern system fails or, less apocalyptically, as an asset that should keep pace with inflation. Inflation has been essentially non-existent over the stretch, so ask yourself: Has the end of the world as we know it become four times more likely in eight years?

The other asset class on a huge tear is bonds. Historically, bonds are less volatile than stocks, and Treasury bonds are viewed as nearly risk-free because they’re backed by the full faith and credit of the U.S. government. Since 2008, 10-year Treasuries have averaged a 7.0% return versus the 2.9% return of the S&P 500.

Yet big questions remain. First, if the case for safety is the credit of the U.S. government, why should bonds be increasingly popular and pricey when our country suffered its first-ever downgrade in 2011? Moreover, bond yields are extremely low. For instance, the one-month T-Bill currently has a 0.10% yield and no other true source of return. If you invested $100 with such a return, you would have $110 a full century later. And the 10-year Treasury yield is just 2.0%–about one-third the income such bonds have provided long-term and among the lowest on record. Finally, as with other asset classes, bond prices can go up–and down. Should yields go back to the normal range, bonds could lose 20% or more.

There are less provocative aspects to this rage for safety. Utilities and consumer staple stocks look expensive relative to other areas in history. Dividend stocks look a bit frothy. Oodles of cash are sitting on corporate and personal balance sheets, despite no current return.

Don’t get caught up in this panic. First, after you’ve established an emergency fund and invested across several asset classes, you’ll likely be just fine. Second, pay attention to price–don’t blindly buy gold because you’re worried or because others have made money there. And as an economist friend said, don’t trade the possibility of losing money (in stocks) with the near certainty of doing so (in bonds). Finally, think independently and opportunistically. If everybody else is selling stocks and buying bonds, that gives you an opportunity to go in the other direction for even better returns than you would
normally get.

Mellody Hobson is president of Ariel Investments L.L.C., a Chicago-based money management firm that serves individual investors and retirement plans through its no-load mutual funds. For more valuable financial tips, visit or follow @ArielFunds on Twitter.