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Bond Investment Strategies

- Alan Lavine and Gail Liberman

When interest rates rise, bond prices fall.

We've already seen some damage. Interest rates are up more than 1 percent this year. As a result, the value of the 10-year U.S. Treasury bond has declined 2.4 percent, while the 30-year bond is down about 6 percent. If interest rates go higher, as some say they could, expect more losses. You may limit your bond damage by considering one of the following investment strategies.

The simplest thing is to buy and hold your bond so that you get your principal back when it matures. Before it matures, the value of the bond will fluctuate--rising when rates fall and dropping when rates rise. So it's best to set aside a cash emergency fund. This way you won't need to sell your bond when the market moves against you.

Swap bonds. Talk to your financial adviser about selling your losing bonds. You can write off the loss on your taxes and reinvest in the money in a higher-yielding investment with the same credit rating.

Dollar cost average. Invest a regular amount over a period of time in bonds. This way, you will purchase bonds at a lower price when rates rise. Over time, the average cost of your investment ultimately should be less.

Ladder maturities. Buy bonds so that they mature at various intervals--in consecutive years, for example. This way, your total bond holdings should earn more if rates rise than they would if you invested them in a single maturity today. Maturing bonds may be rolled over at higher interest rates.

An important word about bond funds: Bond funds do not mature. So there is no guarantee that you will get your principal back. The share price of a bond fund continuously fluctuates.

John Bogle, former chairman of the Vanguard Group, says that if you are a long-term bond fund investor, don't worry about temporary declines in the market value of your fund. Instead, look at the total return of the fund over the long term. Total return is interest plus the percentage increase or decrease in the value of the bond fund. Bogle's research shows that if you simply reinvest your distributions and capital gains over 25 years, your bond fund should increase in value. Reason: During periods of high interest rates, you are reinvesting in more shares of the bond fund. So when interest rates finally fall, the value of those shares should increase in value.

Dollar cost averaging, incidentally, works particularly well with bond funds.


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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