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Stick with shorter-term government bonds

- Alan Lavine and Gail Liberman

For your bond investments, consider sticking with U.S. government bonds that are non-callable and have maturities ranging from one to five years.That's the upshot of research by two executives of McLean Asset Management Corp., in Virginia.

Alejandro Murguia, Ph.D., director of investment research, and Dean T. Umemoto, CFP, president, say it's tempting to invest in longer-term bonds. After all, long-term bonds typically pay significantly more interest than shorter-term bonds.

However, there's good reason for this. When interest rates rise, a bond loses principal if you go to sell it. The longer the bond term, the more you risk losing in a rising-rate environment.

Say interest rates rose 1 percent: A two-year U.S. Treasury bond would lose close to 1.90 percent of principal while a 20-year U.S. Treasury bond would lose about 10.15 percent of principal if you go to sell it. If issuers of long-term bonds didn't pay so much interest, nobody would buy them.

Is the higher yield really worth the risk?

Meanwhile, a critical reason many investors hold bonds is to cushion their losses if the stock market heads South.

During market upswings, Murguia and Umemoto say in the Journal of Financial Planning, bonds usually follow the performance of stocks. But because bonds normally don't do as well as stocks, financial advisers too often try to compensate by investing in riskier, but higher-yielding corporate bonds and longer-term bonds.

However, bonds help cushion stock market losses. When the stock market drops, bonds "decouple" from stocks. This means they don't fall in value as quickly as stocks, and might even gain a little.

The shorter-term bonds show greater independence from stocks than longer-term bonds.

In market declines, corporate bonds and mortgage securities tend to do worse than U.S. Treasuries.

The authors confirmed earlier studies that indicate when investing in bond mutual funds, you're typically better off sticking with an index fund rather than an actively-managed fund.

This primarily is due to the fact that you're paying higher fees for active management. The added fees come directly out of your returns.


Spouses Gail Liberman and Alan Lavine are syndicated columnists. Their latest book is "Rags to Retirement (Alpha Books)." You can e-mail them at MWliblav@aol.com.

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