Reader Q+A: Bond Talk

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Several readers have emailed wanting me to talk about bond funds/ETFs in this current market environment. Here’s one request:

Would you please share your thoughts on investing in bond funds/ETFs? Several articles talk about the possibility of raising interest rates resulting in a drop in bond prices.

Would you recommend keeping the bond portion of the portfolio in money market or CDs?
I realize that you do not talk about bonds much. So, I will not be surprised if you do not want to respond to this.

The above 1-year chart shows the Total Bond Market Index (BND), which is best suited to look at the big picture in the bond market.

The current trend is clearly recognizable, as bond prices have declined, and interest rates have risen, as an unintended result of the Fed’s implementation of the Quantitative Easing program (QE-2) back in September 2010.

Most recently, however, prices have bounced off the bottom and headed back up, but it’s too early to tell if that is just a temporary blip in a declining market.

There are two main reasons why an investor would invest in bonds. One, to generate income, and two, to balance a growth portfolio. These are entirely different objectives and need to be treated as such.

If you are looking strictly for income, you are in a difficult situation as the slide in bond prices pretty much has eroded the annual dividend you were looking for. You might want to consider adding some utility ETFs, as I briefly discussed in Income Plays.

If you are holding a growth portfolio, even within the frame work of trend tracking, a bond portion is an important component to balance out temporary market pullbacks.

That point was just proven during this past week when the Libyan crisis pulled the rug out from under the equity market. As stocks retreated, bonds rallied, supporting the view that a portfolio with exposure to various asset classes is very necessary.

While the markets staged a recovery yesterday, it’s my belief that in this global environment, where unexpected uncertainties can pop up at anytime, a balanced portfolio, along with a clearly defined exit strategy, is an absolute must.

While that might curtail some of your upside potential, the downside risks given the current lofty levels of the market, along with a wide variety of ever increasing global hotspots, are far too great to be ignored.

Disclosure: Holdings in BND

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Comments 2

  1. Dear Ulli: Thanks for the excellent post on bonds. If we feel that interest rates are going to rais, would you recommend individuals to keep the bond portion of thei investment in money markets (or short term CDs), instead of investing in Bonds – due to the possiblity of increasing rates and hence reduced prices. Thanks for your thoughts.

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