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Barron’s Got Bond Funds Right… And, Wrong.

July 14, 2015

This week’s Barron’s cover story proclaiming, “Trouble Ahead for Bond Funds” is partly right and partly wrong.

The part of the sub-headline that says, “But, with interest rates likely to rise, investors could soon face losses” I agree with.  I disagree with the beginning of the sub-headline that says “Bond funds have long been prized for their income and stability.”  They have neither been a bastion for income or stability.  This is confirmed by the sub-headline in the cover of their special mutual fund section that says “Bond funds don’t offer much income, and their stability is less certain than ever.  Investors need a new approach.”  However, Barron’s approach in the article is not new and it contradicts the well-developed beginning which is an excellent analysis of the non-validity of bond funds as a secure portion of a portfolio.

The reality is that bond funds are not secure or stable.  They fluctuate widely.  Proponents of bond funds point to the great gains of such funds over recent years.  However, these gains were the result of falling rates which would be reversed if and when rates rise. Further, many fund managers chased these gains by loading up on Treasury Bonds that were poised to increase as rates fell.  However, the payouts were ridiculously low not even matching the low inflation rates.  Yet during this period their advertisements touted the great “total returns” – the combined increase in value plus the interest payout.

My contention is that the average investor, who is the typical target of the purveyors of bond funds, buys such funds expecting a steady cash flow and a predictable return of their investment.  They have been receiving neither.

Where I disagree with the article is when it suggests “a small allocation to an intermediate-term bond fund as ballast against big stock market losses.”  This advice is then justified as the potential for losses with this being less than the losses one might experience in the stock market.  The article also makes other suggestions indicating that in some circumstances some types of bond funds might be advisable and actually closes with mentions of bond funds to consider.  I totally disagree with this.  I don’t believe there is any situation bond funds should be owned by investors seeking stability of regular interest payments and principal.

I agree with the article that fixed income investors should buy individual bonds and should acquire a diversified quantity on some sort of laddered basis.

Investing for fixed income cash flow or interest accumulation is complicated, and in today’s low interest environment it is very difficult to know what to do.  I presented a plan with my reasons in my February 25 and 27, 2014 blogs, and the ideas are still valid.  For those still not sure what to do, read the Barron’s article, stay away from bond funds and think about your ultimate investment goals and how they might be achieved, and whether bond interest could do it for you.

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