The world's safest investment just got more dangerous

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It wasn't concern about inflation that caused Friday's slide, but suggestions by Federal Reserve board member Eric Rosengren that interest rates may rise sooner than expected. Higher short-term rates are typically bad for bondholders. People become more reluctant to tie up their money for a decade to earn, say, 1.6% if they can earn something like that in short-term paper. So when short-term rates rise, long-term bond yields typically rise to compensate. And that means long-term bond prices fall. (Bonds are like seesaws: When prices fall, the yield rises.)

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Few investors today can remember anything but a bull market in bonds. The Treasury market bottomed out in 1982 and has been largely on the way up since then. But bonds are called "fixed income" for a reason. The coupons on your bond won't rise. So there is a limit to how much you should pay for them.

Future generations may look back on this moment with amazement. They may ask, "What were people thinking?"... It is depressingly predictable that John and Jane Doe are still piling into bonds at current prices. So far this year the U.S. public has poured $165 billion more into open-end bond mutual funds and bond exchange-traded funds. In total investors have placed $4.1 trillion into bond funds. Most worrying is that, due to cookie-cutter financial planning, the people holding the most money in bonds are typically older, retired investors who rely on their investment income.