Wednesday, December 15, 2010

Bond Funds

Bond funds are mutual funds that lend their money to corporations or governments. Lately everyone seems to be buying bonds funds. Because you need less money to begin investing in bond funds than you do to buy an individual bond, a bond mutual fund may seem to be a good choice.

I cannot state strongly enough how much I do not like bond funds in this economic environment.

First, mutual funds are not my first choice for investing; although, I have to admit that I too have invested in mutual funds when it is not feasible for me to invest directly. Of all mutual funds, I dislike bond funds the most because you are never sure when or even if you will get your principal returned. More of your invested money goes to expenses than with an individual bond, and you lose all control over when to sell.

You see bond funds hold groups of bonds and they buy and sell them based on changing economic conditions. Memorize this principle: when interest rates go up the value of bonds goes down. No exceptions exist. Since interest rates right now are about as low as they can get, bond funds are very expensive and pay relatively little for the risk you take. It is true that the price of an individual bond will fluctuate as economic conditions change; however, a well-selected bond will pay back your principal upon maturity. With a bond mutual fund, you have no such expectation.

I fear for those who have poured their money into bond funds for safety or fixed income. This is no way to invest. The economy may be in deflation, interest rates will stay low, and the bond fund holders will not lose any money. However, I have been in this business too long to accept the premise that interest rates are going to stay low forever. When they do go up, this will be the next bubble to burst. Why take that risk when as an investor you can very easily buy one or more quality bonds for a relatively small amount of money.

Once you have saved about $2,000, you can buy a bond. Use my five step-planning guide to help you develop a comprehensive investment plan. Figure out how much money you want in bonds, stocks, or real estate. If you decide lending your money is a good investment for you, then please buy individual bonds rather than bond mutual funds.

Periodically, I review bonds that I think are good buys. Read my blog often to help you decide which bonds to buy.

Very Truly Yours,

TheMoneyMadam