There was a time when owning the best bond funds wasn’t that important, but if you don’t own the best bond funds in 2015 and beyond, you may not want to own any at all. For many years, these income-generating funds were considered relatively safe investments, and they also proved to consistently perform well.
These funds are also called INCOME FUNDS. Their goal: to generate higher interest income, as relatively safe investments. When you invest in them, you own a very small part of a very large portfolio of FIXED INCOME debt securities called “bonds.” Let’s keep things simple here to remember the most important thing you need to know about them: In 2015 and beyond, even the best bond funds will not be safe investments.
In 1981, interest rates reached all-time highs and then declined for many years, recently reaching all-time lows. Fixed income produced in income fund portfolios became increasingly attractive vs. current rates. The result was: good dividend income and RISING STOCK PRICES for the fund owners. It was not necessary to have the best bond funds. A rising tide lifts all the boats.
For a good number of years, the average income fund outperformed the average stock fund … and, unlike stock funds … they did not generate large losses to investors every few years. It’s no wonder that millions of investors have become devoted followers of these funds and continue to view them as good safe investments. Why should you worry about owning only the best bond funds in 2015, 2016 and beyond?
Look at today’s interest rates. You’re lucky if you can get 1% interest income on a one-year CD or 3% dividend income from a quality income pool. In 1981 you could get 15% of the CD and an income fund. Today, to get more than 3% in dividend income from bond funds, you have to go junk quality or own a long-term fund; And the average conservative investor doesn’t want junk (low-quality) funds because they are definitely not safe investments. Note: long-term fixed debt has a higher interest rate due to risk related to the time factor.
You’ve seen how income funds behave when interest rates are falling, but I didn’t tell you this: the best bond funds when interest rates are falling are long-term funds. After all, your portfolios contain higher interest rate debt securities that are fixed and locked in for 20 years or more. Now, you ask, what happens if interest rates go up?
When rates go up, you are seeing the other side of the coin. Even the best bond funds WILL LOSE MONEY, but long-term funds could be slaughtered. That is not just likely; this is how the world of finance works. When rates peaked in 1981, long-term funds approached 50% losses. In other words, even the best bond funds are not truly safe investments.
Investors’ main concern in 2015 is “interest rate risk”. When rates go up, investors in income funds will lose money. Don’t worry too much about quality (but avoid the junk). Be very concerned about the average maturity of a fund’s portfolio (long-term vs. shorter-term). Avoid long-term funds. The best bond funds for 2015 are called interim funds and their portfolios contain securities with maturities of 5 to 10 years. Look for one with an average maturity of about 7 years. While these are not really safe investments, they have much less interest rate risk than long-term funds.
The best bond funds also have low costs and expenses; and without sales charges called “charges.” Most people should have income funds to provide the full balance of their portfolio. In 2015 and beyond, choose the best bond funds to keep your overall risk at acceptable levels.