Bonds and bond funds facing challenges


Investors interested in bonds face a difficult economic and interest rate environment. Inflation in 2021 is above 6% and it and real GDP growth are expected to be around 3% by 2022. These suggest, along with Fed statements, that interest rates are now close to their target. all-time lows will increase. When interest rates rise, current holders of individual bonds or bond funds will suffer losses. For example, investors who bought broad-based bond funds at the start of the year likely suffered losses of around 2%.

These realities leave current holders of bonds or bond funds with different challenges. Holders of individual bonds will experience a temporary loss of principal until the bonds mature. Unless they have to sell before then, they will eventually get back the full value of their bonds. Holders of bond funds may never be unscathed if interest rates do not fall, as bond funds typically do not have a maturity date.

Investors who want to invest in fixed income now face these issues and must also decide whether individual bonds or bond funds are best suited to their needs, and what percentage of a portfolio should now be in bonds?

Unfortunately, there is no “right” answer to this last question. It depends too much on individual circumstances. I have seen cases where 0% in bonds was appropriate and others where 70% was. In my opinion, stocks are the investment for wealth growth and bonds for a good night’s sleep. Thus, investors should only hold a sufficient amount of bonds to be comfortable with the rest in stocks. One guideline is to keep enough bonds to pay all the bills for two to four years without selling shares just in case the market goes down. Usually no more than four years as even bear markets will recover by then.

Whether individual bonds or bond funds: For investors with significant capital, I favor individual bonds. This is because some of the strengths of bonds are diluted in bond funds. While their values ​​can fluctuate, as noted earlier, individual bonds have a certain date that patient investors know will be full, and they can control those dates.

Again, this is not true for bond funds, since these have many bonds with different maturity dates and are constantly trading them, they do not have a maturity date. In addition, their value is inversely correlated with interest rates. Thus, if interest rates rise, investors may never receive repayment of their principal. However, the interest paid by the fund will tend to increase as they still have bonds coming due and can reinvest at higher rates.

There are other tradeoffs between individual bonds and bond funds. For small investors, the bond market is less profitable than the stock market. This means that they will incur higher costs when they buy a bond. Since bond funds buy a large number of bonds, they have the power to minimize these costs. Although the buyer of individual bonds may pay an initial cost, there is no charge when the bond matures. On the other hand, the buyer of the bond fund pays an annual management commission and possibly other costs.

All data and forecasts are provided for guidance only and do not constitute an invitation to buy or sell any security. Past performance does not represent future results. If you have a financial issue that you would like to see covered in this column or have any other comments or questions, you can contact Robert Stepleman c / o Dow Wealth Management, 8205 Nature’s Way, Lakewood Ranch, FL 34202 or at rsstepl @ tampabay. He provides advisory services through Bolton Global Asset Management, an investment adviser registered with the SEC and associated with Dow Wealth Management, LLC.


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