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Navigating the Bond Market

Posted by Larry Doyle on August 3, 2009 12:16 PM |

Where should people invest these days?

Are we to believe the price action in the equity markets?

With short term rates on CDs and money market funds ridiculously low, where does one turn to make a safe investment with limited risk?

Prior to putting any money to work, always make sure you look at an investment in the context of an overall portfolio. Diversity and prudent risk management never go out of style and should be the cornerstones of any portfolio.

Sense on Cents recommends short to intermediate bond funds.  I am concerned about longer maturity interest rates moving higher (in fact they have moved considerably higher this morning). As such, I would stay away from bond funds with longer maturities in the underlying investments.

What are some of the road signs investors should look for in navigating the bond market? The Wall Street Journal provides a very handy overview this morning, The New Bond Equation:

As the financial crisis heads into its third year, investors in bond funds are facing some difficult choices.

Investors usually turn to these funds for safety. But bond funds are facing a host of pressures that are driving down returns, raising long-term risk—and making it tougher to settle on the right investment strategy.

Let’s navigate!

1. Default Risk
Do not be presumptuous and think the portfolio manager is carefully managing individual exposures in a bond fund. Investors need to look into the actual portfolio of bonds and ask brokers or financial planners on questionable credits.

2. Interest Rate Risk
In the presence of a massive fiscal deficit and the likelihood that the deficit will grow, interest rates are likely to head higher. A rising rate environment means declining bond values, which is why I recommend short to intermediate maturity bonds which will be less impacted.

3. Passive Investing via Index Funds
Maximize diversity and minimize expenses.

4. What About the Perils of Inflation?
Gain some exposure to TIPS (Treasury Inflation Protected Securities) and commodity funds.

5. Should Investors Try to Time the Market?
Sense on Cents ALWAYS recommends a dollar cost averaging or value averaging approach, in which an investor puts in a set amount of money every month. NO investor or portfolio manager is so good as to pick the top or bottom in a market, despite what you may hear.

Discipline is critical every step of the way. Do your homework prior to investing. Make sure the execution at point of investment is handled properly. Monitor your investments as you move forward.


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