Your best bond fund strategy is to assume that a bond bubble in 2012 is for real, and you need to find the best bond funds to invest in because this bubble could burst. What's a bond bubble and which are the best funds to invest in?
To get a handle on the best bond funds and the bubble you'll first need a basic understanding of bonds, which are simply debt securities issued by government entities and corporations to borrow money from investors at a FIXED interest rate for a FIXED period of time, like for 20 or 30 years. At the end of that time period they mature and bond holders (like individuals or mutual funds) are paid back the amount originally borrowed. Throughout the life of these securities they trade in the open market like stocks do and fluctuate in price or value.
Since interest rates in the economy change and the rate for existing bonds is FIXED, falling rates in the economy make bonds in the marketplace more attractive and investors bid UP prices (value). Rising rates send bond prices DOWN. All bond funds are affected by this "interest rate risk", even the best bond funds. Long term funds that hold securities that mature in 20 to 30 years are MUCH more affected by the risk of changing rates than those holding securities maturing in 5 years or less. Long term bonds and funds that invest in them pay higher interest income than do their comparable shorter term counterparts, but who wants to stay locked into a low fixed interest rate for 20 years when rates are going up?
The best way to visualize a bubble in an investment market is to think in terms of inflated prices. With interest rates breaking record lows, bond prices have hit record highs. For the past 30 years rates have basically been falling. You didn't necessarily need to be in the best bond funds until recently, because the trend was your friend and this was good for all bond investments. In 2012 and beyond this bubble of high bond prices caused by extremely low interest rates threatens to deflate or even burst. Every financial bubble in history has ended by going through a price adjustment. Being invested in the best bond funds and avoiding the riskiest is now of utmost importance.
Believe it or not, some of the riskiest bond funds today hold some of the safest debt securities in terms of high quality: LONG TERM U.S. Treasury bonds, the safest bonds in the world. Funds holding government securities maturing in 20 years or more (on average) put you at risk of significant loss if (when) rates go up; and you're lucky to get more than 2% a year in income after fund fees, charges and expenses. In the best bond funds you can earn higher income with much less interest rate risk - which is the risk you need to be concerned about in the bond bubble of 2012. The risk of the possibility of a default by the U.S. Treasury is NOT the issue here. The bond bubble is the issue. A gradual rise in rates will deflate the bond bubble. An explosion in rates will burst the bubble.
Remember that when you invest in bond funds you can make money in two basic ways. First, through interest income, which recently hit all-time lows due to record low interest rates; second, from the value of the bond portfolio in your fund going up, primarily due to falling rates. You lose money when rising rates send the value of your fund's bonds down.
The best bond funds for 2012 and beyond will hold bonds maturing in about 5 years vs. 20 or more. This reduces your interest rate risk. The best funds will invest in CORPORATE bonds of medium to high quality, because these securities pay considerably more interest income than GOVERNMENT debt securities. And the best funds will be those offered by the largest fund companies with the lowest fund expenses (and no sales charges)... like Vanguard and Fidelity.
Whether the bond bubble of 2012 melts away over time or bursts from rapidly rising interest rates, investors can take significant losses if they are in the wrong bond funds - long term funds. Your best bond funds for a respectable interest income without high risk are intermediate to short-term corporate bond funds with low expenses and no sales charges. To find these search for "no-load bond funds" on your favorite search engine.
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Author James Leitz teaches investment basics, stocks, bonds, mutual funds and how to invest in his investing guide for beginners called INVEST INFORMED. Put Jim's 40 years of investing experience to work for you and get up to speed at http://www.investinformed.com. Learn how to invest.
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