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Bonds can be risky too

- Alan Lavine and Gail Liberman

Are you finally getting around to investing in bonds?

If so, be careful. Bonds can be just as volatile as stocks.

Here are some of the risks you face when you buy bonds:

  • Credit risk. A company issuing a bond could go bankrupt. Anyone who owned Enron, WorldCom and Global Crossing bonds is hurting. The companies went bankrupt. The bonds now are worth a few cents on the dollar.

  • Lost opportunity risk. You could invest today at fixed rate only to see rates go higher tomorrow. So you've missed out on the opportunity to earn a higher yield.

  • Interest rate risk. Bond prices and interest rates move in opposite directions. So if rates rise, bonds price fall. The longer the maturity, the greater the loss.

  • Inflation risk. You're depending on income from bonds. However, the prices of everything you need to buy are rising. So the income you're getting from your fixed-rate bonds buys less.

    William Gross, manager of the Pimco Total Return Fund, says you should own different types of bonds. Gross is the best-rated bond fund manager, according to Morningstar Inc., Chicago. He suggests:

  • Put one-third of your bonds in Treasury Inflation Protection Securities. This way, the principal of the bonds may appreciate in value along with inflation.

  • Put one-third of your bonds in Ginnie Mae mortgage bonds. These bonds are back by the U.S. government. They pay higher yields than U.S. Treasury bonds.

  • Put one-third of your bond investment in high-quality corporate bonds, rated single A to triple A by Standard & Poor's and Moody's. This lets you earn some higher yields from the financially strong corporations.

    You can invest in individual bonds or bond funds. With individual bonds, you collect semiannual interest and get your principal back when your bonds mature. By contrast, your bond fund never matures. So the price of your fund will fluctuate. You can either make or lose money--depending upon when you sell your bond fund.

    High-tax-bracket investors should consider insured municipal bonds or municipal bonds rated single A to triple A. These are tax-free bonds. You can buy municipal bonds that are both state tax-free and federally tax-free.

    Always stick with the highest quality investments that pay the best yields. Don't gamble. The higher the yield, the greater the risk.


    Alan Lavine and Gail Liberman are husband and wife columnist and authors of The Complete Idiot's Guide To Making Money With Mutual Funds, (Alpha Books).

    To read more columns, please visit the column archive.

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