Investing In Bond Funds? Follow These Rules Of Thumb
By Thomas E. Nugent
The last time interest rates were as low as they are today, the Beatles were the newest craze in America.
Back then, individual investors used either savings accounts or equities to save for retirement. In fact, most retirement benefits were provided by employers through defined benefit pension plans that provided a reliable income during retirement.
Times have changed over the last 40 years. The shift from defined benefit to defined contribution plans by employers has forced many individuals to take control of building their retirement nest egg.
The many options available do provide unprecedented flexibility, but they also inject an added degree of confusion. One example is the bond mutual fund. These are very popular in periods of stock market volatility, but investors and advisors need to follow a few rules of thumb before plowing hard-earned money into these funds.
Do not let bond mutual fund advertisements and of past returns mislead you. In conjunction with my associate, Warren Bitters, we screened 162 government bond funds listed in the Morningstar database and found that they turned an 8.44% average total return through Aug. 31, 2002.
Thats a good return, especially when contrasted with simultaneous stock market declines. Given these positive returns, many mutual fund companies have heavily advertised their bond funds results. However, these returns may be difficult to duplicate.
Rule 2: Start with the current yields on bonds as a proxy for your expected return.
One factor limiting investors potential return in the current investment environment is low interest rates. The yield on the 10-year Treasury note is slightly below 4%, while the yield on two-year Treasuries is a miniscule 2%. A mutual fund that invests in these securities should yield somewhere in the 2% to 4% range, less administrative and management expenses.
Rule 3: Know the risks of bonds selling at premiums.
