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Are Bond Funds Good Investments for 2012?

March 02, 2012 | Comments: 0 | Views: 77

Bond funds have been good investments for 30 years, while stock funds have only sometimes been good places to invest money. In fact, bond funds have outperformed stock funds, which is highly unusual. Why have they been such good investments, and will they still be a good place to invest money for 2012 and beyond?

Investors make money in bond funds in two different ways. First, they make money from the interest earned in the fund portfolio, in the form of dividends. Second, they make money when the share price of a fund goes up. Since the early 1980's interest rates in the USA have been falling, and in 2012 they are at record lows. When rates fall bonds go up in price (value). That's why bond funds have been such good investments. Period. Memorize that.

On the other hand, when interest rates go up these funds are not good investments - they are losers. The reason they are not a good place to invest money when interest rates are rising: the bonds in their portfolio pay an interest rate that is FIXED for the life of the investment. Rising rates make them less attractive and less valuable as an investment alternative. Hence, bond prices fall. And that's what bond funds invest money in: bonds.

Years ago, these funds were paying lofty dividends when interest rates were high. In 2012 you're lucky to earn 3% or 4% in dividend income in high quality bond funds, after fund expenses. How can you make money if you collect 3% a year in dividend income while the price or value of your fund falls 20%, 30% or more? You can't. And it could happen in 2012, 2013 and beyond if interest rates go up. When the rates start going up, this is not where you want to invest money.

In your search for good investments always consider risk vs. reward. In order to make more than 4% a year in high quality bond funds interest rates need to keep falling. With the world's safest bonds (U.S. Treasury bonds) paying 3%, while 30-yr. mortgages are at 4% and 1-yr. CDs at 50%, how much lower can rates go? The risk is too high for the reward of earning a miserly 3% or so. If you invest money in these funds keep one eye on interest rates and one eye on your investments.

The easy days to make money in bond funds is over. The day the USA's central banker (the Federal Reserve) stops pushing interest rates lower, rates could rise. This may not happen until later in 2012 or in 2013; but beware. When rates rise these funds will not be good investments. You need to invest money somewhere, but don't load up on bond funds now. You want to make money - not lose it.

Author James Leitz has 40 years of investing experience and would like to help you learn how to invest. Get up to speed on how to invest at

Source: EzineArticles
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