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URL:  http://boards.fool.com/good-previous-answers-bond-funds-are-basically-a-30695552.aspx

Subject:  Re: Worst case for bond funds Date:  5/21/2013  5:51 PM
Author:  jackcrow Number:  34956 of 35387

Good previous answers.

Bond funds are basically a business that invests in bonds. If business is good the share holders do well, if business is bad the share holders do poorly. Its almost like investing in a commodity company like X (united states steel) when steel is needed X tends to do well, when steel isn't needed X limps along.

The greatest risk is principal loss. Currently a commercial grade bond fund holds primarily bonds bought at a premium because much of that portion of the bond landscape has been priced with a premium for a long time. As interest rates rise that premium will dwindle if not completely disappear. Duration of a fund also dictates buying and selling; funds tend to hold a range of maturities, outside that range they buy or sell. For years these mid and long range funds have been forced to sell and buy into a rising market. It all looks good on paper, but over paying for anything rarely ends well.

A long time ago this board conducted several studies on what bond funds are likely to do through multiple up and down cycles. The primary conclusion is that if one reinvests the dividends the higher yield does not make up for the loss in principal. If one does not need to tap into the principal the rising dividend yield might be beneficial but it will not off set the loss in principal. If they ever need to start drawing down on the principal they will be eating a significant loss.

jack
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