Bond Fund Investors Beware

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Income investors are reading “Bill Gross Warning May Catch Bond-Fund Investors Off Guard:”

Bill Gross’s warning that the almost three-decade rally in fixed-income has run its course may catch individual investors off guard after they poured $89 billion into bond funds this year.

The inflows through yesterday are running almost five times higher than deposits during the first three months of 2009, according to Brad Durham, co-founder of Emerging Portfolio Fund Research Inc., a Boston-based firm that tracks investor flows worldwide into mutual funds and exchange-traded funds. Investors reeling from losses during the financial crisis poured record amounts into fixed-income funds last year, missing the biggest stock market rally since the 1930s.

“The continued inflows make you scratch your head,” Miriam Sjoblom, a bond fund analyst at Chicago-based research firm Morningstar Inc. said in an interview. “We’ve seen time and again investors make these kinds of tactical decisions at the wrong time.”

Pacific Investment Management Co.’s Gross, manager of the world’s biggest bond fund, said yesterday in an interview with Tom Keene on Bloomberg Radio that “bonds have seen their best days.” Pimco, which announced in December that it would offer stock funds, is advising investors to buy the debt of countries such as Germany and Canada that have low deficits and higher- yielding corporate securities.

The prospect of a strengthening U.S. economy and rising interest rates makes an “argument to not own as many” bonds, Gross said in the interview.

Does this mean you should sell all bond funds now? Of course not. It’s just Bill Gross’s viewpoint that eventually interest rates will rise and bond funds will suffer as a result. The timing of it is totally unknown, and the assumption is based on the fact that the economy is indeed strengthening.

I could make the counterargument that with the scheduled tax increases in 2011, the economy could very easily slip back into a recession, which would bode well for bond funds.

Since no one has the answer, it pays to simply follow the trends. If you are concerned about higher rates, simply establish a trailing sell stop for your bond fund positions just like you would for your equity fund holdings. You may want to use a lesser percentage (maybe 5%) than my recommended 7% for equities.

That’s it! You now have a plan in place to deal with any market uncertainties and no longer need to spend your day worrying as to what your plan of action should be.

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