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Investing in Bond Funds

Posted December 19, 2012 in Advice Column, Grimes

If you don’t want to invest all your assets in the stock market, you may need to consider either cash or bonds for your portfolio.

While cash is relatively safe, returns are likely to be less than 0.50 percent given the low interest-rate environment. Bond funds are an alternative, but most people don’t have a good understanding of what to expect. You may want to consider buying a bond fund to give your portfolio stability or help generate income. Unlike individual bonds, bond funds hold a number of fixed-income securities with varying maturities. Therefore, investing in a bond fund provides a diversification benefit. In order to save yourself from making costly mistakes, it helps to thoroughly check up on what a bond fund owns before you buy in. Two basic determinants of bond performance are interest-rate sensitivity and credit quality.

Interest-rate sensitivity is important because an inverse relationship exists between bond prices and yields. If interest rates fall, bond prices rise and vice versa. The credit quality tells you how risky the bond fund is, which can help determine if the fund fits your risk profile. Consider these factors before you go bond-fund shopping. Just as you wouldn’t want to have all of your stocks in one style, you also want to diversify your bond portfolio. A well-rounded bond portfolio should have some exposure to most of the following bond types: Government, mortgage-backed, municipal, corporate and world bonds. It is important to understand that the right combination of bond funds ultimately depends on your investment goals and risk profile.

Bond markets are extremely active, with interest rates constantly changing due to a number of factors including supply and demand of credit, Federal Reserve policy, economic conditions, fiscal policy, issuer risk and, above all others, inflation expectations.  If you are thinking about buying a bond fund, or have recently bought some, you should be aware of the risk that interest rates have on your bonds. Let us help analyze your current bond portfolio so you know how these variables could impact you and your investments. If you have questions about the effects of interest rates on your bond funds or would like to know if you are diversified properly, please come see me at City State Bank, or call me at (515)986-2265.

Not FDIC Insured, Not a bank deposit or product, Not guaranteed by bank, May lose value and is subject to investment risk including possible loss of principal.

Information provided by Wade Lawrence, City State Bank, 100 N.E. Jacob St., Grimes, 986-2265.

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