Market Lull a Chance to Change Portfolio
By MICHAEL J. MARTINEZ, AP Business Writer
NEW YORK - Although bond mutual funds rose along with stock funds over the past year, investors tended to overlook them in favor of equities with soaring returns. Bonds were seen as an investment for the timid, or those hoping to retire soon.
Anybody who's seen their portfolios drop this month — which means almost everyone invested in a stock mutual fund — should be thinking twice about that assessment.
Bonds are far less risky than stocks, their returns are higher than money markets and they're an important part of a balanced portfolio. Buying them individually can be somewhat confusing, however, which is why bond mutual funds are more popular with investors seeking to diversify their holdings and hedge against another downturn in stocks.
"Diversification is so valuable, yet so many people just don't do it," said Diane Maloney, president of Beacon Financial Planning Services in Plainfield, Ill. "Your portfolio should not be made up of what was good last year. It should have bonds or bond funds in it."
Bond funds operate like any other mutual fund. You pay into the fund, and a manager chooses bonds to purchase. But because bonds aren't subject to the same volatility as stocks, there's less risk in bond funds. Of course, the returns aren't as high, either.
Bond funds are usually categorized by the kind of bonds purchased. For example, a high-yield fund might invest in long-term bonds issued by corporations, some of which might have negative bond ratings — which means there's a chance the company might default on the bond. Because of that risk, returns on such bond funds can fluctuate from positive to negative.
Funds are also characterized by bond terms. Short-term bonds, which mature in five years or less, tend to have lower returns than long-term bonds, which won't mature for 30 years or more.
The most stable funds tend to focus on government-issued bonds. While their returns are generally small, there's less chance of default and only a small chance that you'll actually lose money.
"It's really about risk tolerance and what the investor's situation is," said Steve Wetzel, a financial planner in Yardley, Pa., and a financial planning professor at New York University's School of Continuing Education. "Younger investors with some tolerance for risk can go for longer-term corporate bonds, but someone about to retire should probably lock up shorter-term government bonds."
Mutual fund investors seeking bonds in their 401(k) or other portfolios should also think about when they'll want to use the money. Shorter-term bond funds are a good choice if investors need to cash out the principal in less than five years. Good middle-of-the-road options also exist, such as diversified bond funds that mix various terms and yields.
"A stable value option is offered by a lot of 401(k) programs, and that's a good steadying influence," said Thomas Croft, chief investment officer of fixed income investments at Dupont Capital Management. "They have short to intermediate maturity and can generally be counted on for a decent return."
Given the importance of bond funds in any portfolio, experts said there really isn't a bad time to buy. However, with interest rates currently at 45-year lows, it's only a matter of time before they go up again, and fund prices fall.
What should bond fund investors do if they're managing their portfolios or looking to buy now? Taking on longer-term bonds can increase your returns and, in this environment, add little additional risk.
"We're not saying that you should go out and put your money into low-grade 30-year corporate bonds, but you can get a little more yield out of current investments by extending the maturity somewhat," said Harvey Hirschhorn, head of active asset allocation and strategy at the Columbia Management Group.
Investors thinking about high-yield bond funds, or who already invest in them, should be cautious with these longer-term investments for now, Croft said, as they involve the most risk as interest rates rise again in the years to come.
Bond funds are graded like any other mutual fund, with Morningstar issuing their one-star to five-star ratings for the vast majority of them. Experts said these ratings are a good yardstick, but looking at past performance in a similar market can yield even better information.
"If you're looking at a bond fund, take a look at the total return for that fund in 1994, since that was the last year we had low rates that then took a spike upward," Wetzel said. "Some funds got destroyed that year, while others did quite well. It's a good bellwether, as long as those funds have the same management team in place that they did then."
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