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Bond Fund Owners Should Know the Risks

Recent events show bond funds aren’t as safe as you may think

Since early May, interest rates have been on the rise, especially in recent weeks.  The value of outstanding 10-year U.S. government bonds has fallen 10 percent in the last two months.   This is bad news for anyone holding bonds, particularly bond funds.  When interest rates rise, bond prices fall, because investors sell bonds in order to reinvest their money at newer, higher interest rates.  The problem is compounded with bond funds, which are mutual funds that invest in a number of different bonds. 

The Federal Reserve recently suggested that it might slow down its purchase of bonds, an action known as quantitative easing (QE3).   The Fed has been buying bonds every month in order to stimulate the economy, and has kept interest rates low.  If QE3 was phased out, interest rates would rise, bringing bond prices even lower.

The good news is that the drop isn’t as dramatic as it’s being portrayed in the media, especially for long-term investors, and it does not impact those who hold bonds until maturity.  For example, if you own a 10-year bond and keep it until it matures, you will get your 2 or 3 percent interest per year, and it doesn’t matter that the underlying value has gone up or down.  The difference with bond funds is that the funds are often traded before they mature, so the value of the bond does matter.  These bond funds have experienced significant losses during the last two months that have resulted in lower asset values. 

Investors are surprised by the loss – most investors think that bond funds are a safe and guaranteed investment, and this is simply not the case.  Funds can lose their value, as recent events have exhibited, and shouldn’t be viewed as risk-free.

Before you make any dramatic changes to your portfolio or bond holdings, there are a few things to consider.  The first is to make sure you have an investment plan.  Bonds funds can provide a hedge against stock market risk, and the right bond fund may be appropriate to include in a diversified portfolio.  But that will depend on your goals and risk tolerance, two critical components of an investment plan.  Also try to avoid emotional and impulsive decision-making.  When bond values are plummeting like they have in the past two months, it can be easy to get caught up in the hype of Wall Street and make investment decisions that may not be in your long-term interests.  Stick to your investment plan, and make any necessary changes based on calculations, not fear.    

Whether bond funds are right for you, and what you should do if you own bond funds right now, are both topics that should be carefully considered.  If you aren’t sure what your strategy should be, speak with a qualified financial professional who can clearly explain the pros and cons of bond funds to you.  Ultimately, one of the most important tasks for you as an investor is to be educated about your portfolio.  Know the risk of every investment you make up front, before you find out the hard way.

 

ABOUT FORTUNE FINANCIAL GROUP

Christopher Scalese, financial advisor and president of Fortune Financial Group, is best known as Northeastern Pennsylvania’s Retirement Specialist. Scalese has spent the last two decades of his career assisting area residents with the financial transition from the working years to the retirement years. His primary goal is to help individuals structure their finances so that they have a steady income throughout their lifetime, while working to ensure their finances aren’t overly exposed to risk or unnecessary taxation. Scalese is an investment advisor representative, life and health insurance licensed and currently working on earning his Chartered Financial Consultant designation. Scalese received his Bachelor of Science degree in finance and Master of Business Administration degree from Wilkes University. For more information about Christopher Scalese and Fortune Financial Group, please visit www.fortune-financial.org.

Investment advisory services offered through Global Financial Private Capital, LLC,
an SEC Registered Investment Advisor.

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