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Subject:  Re: Worst case for bond funds Date:  5/21/2013  2:04 PM
Author:  Hawkwin Number:  34955 of 36218

What is the worst case for a bond fund holder with no plans to reinvest any income received?

Depending on the duration* of the funds (you can look the funds up on Morningstar), it could be rather bloody.

The bad news with were we currently are with bonds** is the fact that we need not even need to have interest rates go up for bond funds to lose value. The flow of money from bonds to stock will cause prices to deflate. The whiff of a change in monetary policy could have the big players headed for the doors before your small investor has any chance to do anything.

How bad can it be? Look at what those investments did from October 2008 through December 2008. Sure, bonds came back quickly in 2009 but in an inflationary environment, that is not likely to happen as fast.

*Duration is a measure of interest rate sensitivity. A fund with a duration of 4.00 will typically lose 4% value when interest rates move up by 1%, and vice versa.

You asked about the 1970s but I don't think that is a good example. Interest rates on the 10 yr went from about 6% to 15% during that time and bond funds still were slightly positive - but not accounting for inflation and there was no cooresponding increase in yield.

What we have today is very different. Rates have been artificially low for a long time with many bonds in funds maturing with no other investment options but to buy lower interest offerings. We have two problems that make the situation worse - long term low rates and vastly inflated prices. Some treasuries are trading at 140% of their face value. Investments like that don't need an increase in rates to see prices drop as maturity approaches.

Back to 1970. When rates went from 6 to 15, that is an increase of 150%.

Rates today are below 2% We only need to see rates go to 3.5% to have the same percentage increase.

**Depends on the type of bonds. High Yield, international, emerging market, and floating rate (which are actually loans, not bonds) are better positioned to weather an increase in rates.
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