Shopping for bond funds
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November 3, 2000: 7:20 a.m. ET
As the stock market wavers, investors may want to take a look at bond funds
By Staff Writer Martha Slud
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NEW YORK (CNNfn) - For many investors who have been chasing high returns in technology and other growth sectors of the stock market, bond funds may have been the last place they'd thought of stowing some cash. But as the stock market has wavered and tech stocks have tanked, many people may be wishing they had given bonds a closer look.
Investing in the fixed-income market has generally been considered a strategy more appropriate for older investors nearing retirement than younger investors who can afford to tolerate a bit more risk. Some experts say that while bonds were a safe haven during recent stock market tumult, their fundamental advice remains the same: Bonds and bond funds are best-suited for older investors nearing retirement who want to lessen volatility in their portfolios and cushion their incomes with monthly dividend payments.
Most young investors -- say 25-year-olds just starting out in their careers -- can withstand more risk in the equity market and really don't need to hold any bond funds, said Donald Boegel, a certified financial planner in Plymouth, Minn.
"At that age, you should be more investing for growth," Boegel said. "If you are concerned with liquidity needs, a money market fund is really what I would steer them towards."
Others, however, say some exposure to bonds is appropriate for all investors. Certified financial planner Marc Collier, from Wellesley, Mass., uses a classic rule of thumb: Subtract your age from 110 -- the number you're left with gives you a percentage of your assets that you'd put into equities, while the balance would go into bonds. So for someone 30 years old, Collier recommends about 80 percent of assets in stocks and 20 percent in bonds; someone 55 years old would have a 55-to-45 stock-to-bond ratio.
Experts do say, however, that they recommend bond funds rather than individual bonds for all but the wealthiest investors. Unless you have at least $250,000 to invest in specific bonds, the fees are generally too high and the diversity range too low, Boegel said.
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"The bond market still today is not very transparent ... The kind of analytics that we have developed would be unattainable by an individual."
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Brent Harris Chairman PIMCO Funds |
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Bond fund managers – as you might expect – also say that investors interested in bonds are best served by bond funds. Except for Treasury auctions, it's tough for the individual investor to gain broad enough access to the bond market, said Brent Harris, chairman of PIMCO Funds.
"The bond market still today is not very transparent. Quotes are difficult to come by and it's exceedingly difficult to analyze the (market)," he said. "The kind of analytics that we have developed would be unattainable by an individual."
Bond funds also allow investors to shift their strategy relatively easily so they aren't tied to one interest-rate strategy, he said.
Three key factors
So, with that in mind, does it make sense to add a bond fund or two to your portfolio? And what type of bond fund should you buy?
For many investors interested in buying into a bond fund, there's been a dearth of investment guidance of how to choose from the scores of funds available. Stock fund investors, on the other hand, are given volumes of advice: They're told the importance of diversifying – choosing some large-cap and small-cap names, as well as a smattering of international stock funds as well as growth and value funds.
The Schwab Center for Investment Research recently released a report about the most important variables to consider when selecting a domestic bond fund – and, perhaps not surprisingly, the advice isn't too different than the key factors to keep in mind when investing in stock mutual funds.
The Schwab researchers pored through thousands of corporate, government and municipal bond funds, and looked at a number of variables, such as assets under management, the tenure of the portfolio manager, turnover and risk. What they found is that there are only three main factors that investors need to consider: past performance, expenses and risk.
(Click here for the latest bond market rates)
"Out of all those variables that people talk about, you can really narrow that down to a fairly small list," said study co-author James Peterson, vice president of the research institute.
Many people think the tenure of a portfolio manager, for instance, is an important factor – but it turns out not to be, Peterson says. The report found no correlation between length of time the manager ran the fund and future performance. The size of the fund also doesn't appear to make much of a difference, he said.
So keeping the Big Three – past performance, expenses and risk levels -- in mind, Peterson said investors should then look at different types of bond funds that fit their investment profile. He advises investors to "ladder"
their bond portfolio, meaning purchasing a few bonds with varying maturity dates to hedge against being invested at one particular interest rate.
Most bond funds are category specific, such as short-term corporate bonds or long-term Treasury funds. A diversified portfolio could take the shape of one total-market fund that invests in an array of bonds with differing ranges, or a selection of three or four funds in different categories, Peterson said.
"Most bond funds are fairly specific -- in that case, you should probably have a short-term fund; an intermediate fund, and a long term fund," he said.
"If you wanted a little more risk, you might want to consider something like corporate bonds. If you do, make sure you have a Treasury fund too." He said Treasury funds, which are considered low-risk, help balance out the high-risk nature of corporate bond funds.
Collier, the certified financial planner, also said it's important to diversify with a couple different funds. An investor – regardless of age – with $10,000 to invest in bond funds might want an ultra-short term fund, a low-risk investment with a yield just below about 6 percent, and an intermediate bond fund, which is slightly riskier but may provide better returns, he said. Two funds he recommends are the Strong Advantage fund, an ultra-short term fund, and the short-intermediate fund, PIMCO Low Duration.
An investor in a high tax bracket, however, may want to use the same strategy, but apply it to tax-free municipal bond funds, he said.
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