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What to do with Your Bonds Now

- Alan Lavine and Gail Liberman

Interest rates and inflation are at record lows. Chances are both will rise in the future. After all, what goes down must come up. When? No one really knows. If they did, why would they tell anyone about it? They could make millions.

About all money managers can do is make informed judgments. James Midanek, a Walnut Creek, Cal.-based money manger who advises institutional investors, has some strong opinions about what to do.

He says that interest rates and inflation are near the bottom of a 20-year cycle. So there is nowhere to go but up.

In the future, he says, you can expect rising inflation and interest rates. There is a shift from deflation to inflation. That means everything will cost more. And corporations will pay higher rates on bonds.

This is bad news for investors in long-term bonds today. Interest rates and bond prices move in opposite directions. So they could see the value of their investments decline.

So what should you do?

Midanek advises keeping about 40 percent in inflation-indexed treasury bonds. The bond's principal value increases along with the rate of inflation. Invest 40 percent in short-term bond funds, and keep 20 percent in cash. As interest rates rise, the cash investment will move right along with it. That's why money market funds ultimately should be attractive investments.

"If the deflationary part of the investment cycle is nearing an end, this will provide significant inflation protection and greatly reduce unnecessary interest rate risk," says Midanek, a former manager of the Turner Short-Duration Bond fund.

The bottom line of his message: Be prepared now for higher interest rates and inflation. Invest in securities that will do well during periods of rising inflation. Also own short-term bonds. That way, you can roll over money at higher rates.

You can do the same thing with bank CDs. Stay short-term and roll the CDs over at higher rates. In addition, you can invest in bond funds that invest in Treasury Inflation Protection Securities (TIPS). Plus, if inflation is on the rise, gold funds and real estate stock funds may do well. Money funds keep their share price at $1. So you should earn higher rates without seeing your principal decline in value.


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).

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