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Bond Funds

Updated on November 9, 2011

Bond Funds - Hold em or fold em!

Bond funds, also known as bond mutual funds can be good or can be trouble. I offer this opinion after having invested mine and other people's money for many years. While the fund manager is important, they are held captive by interest rate cycles and that is the most important variable in determining if you should invest in bond funds.

Bonds go in cycles that are long lived; sometimes the cycles can last decades. I have experienced 20 years of rising interest rates and 20 years of decreasing interest rates. That would mean, I have been through it all and folks we are repeating that cycle.

Bond funds do pretty well when interest rates go down because the value of the bonds they hold increases; as you know bond yields move in the opposite direction of bond prices. As prices increase, yields go down. Income from these bond funds usually does not increase because as higher yielding bonds mature, they are replaced by lower yielding bonds.

Bond funds do pretty terrible when interest rates go up. For instance, right now bond prices are very high. Bonds are expensive that means bond income is very low. If interest rates go up, and some day they will believe me, the value of the very expensive bonds that make up your fund will go down. Even the best fund manager cannot navigate that math. Bond funds will lose value. Equally, the income from these bonds should increase as the bonds mature they will be replace with bonds that yield more money. You might be tempted to move onto the next Hub at this point but listen up.

Here is where my experience comes in. I have never seen the income from bond funds keep up with the income from owning your own bonds. Furthermore, I never seen the value of a bond fund keep up with the improved value of an individual bond bought at a discount and sold at a premium.

I know I will get a ton of emails with examples of an individual bond fund trade that worked for someone or a fund manager convinced his/her fund is a good investment.

The moral of this Hub is that if you own a bond fund, consider selling while the value of the bond holdings is high. Develop a strategy for investing that money for income. Do not believe any adviser that tells you a bond fund is safe. Every bond holding in the fund can be insured and you can still lose money.

My clients would come to me with a all kinds of existing investments. They thought their bond funds were the safe part of their portfolios. Depending on the interest rate cycle, they could have been right. But in today's world I would not count on your bond fund being the safe portion of your holdings.

That reminds me of the story about the 22% CD...another day.

Yours Truly,



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