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Author: foobar73 Big red star, 1000 posts Feste Award Nominee! Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35365  
Subject: Re: Bond Fund Question Date: 10/29/2002 6:04 PM
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When you invest money into bond funds such as Vanguards is there a time frame that you must leave the money in so when you withdraw it you won't be penalized. Is the time frame different depending on whether it's a short term, intermediate or long-term fund? If there isn't a penalty then why not go into the long-term fund, which seems to pay a higher rate of interest. I feel this is a question I should know the answer to but I have never thought about it and someone ask me today and I had to admit I had never given it any thought.

Most funds charge a fee if you take your money out before some prespecified time. The exact details depend on the specific fund you're looking at. However, this has nothing to do with the question of why everyone doesn't just pick a long-term bond fund.

Bonds, and bond funds, can drop in value when interest rates rise. Rising interest rates mean that bonds on the market become worth less: nobody will want old bonds which pay 7% if they can buy new bonds for 8%. The longer the bond, the larger the potential risk for losses. For very long bonds, losses of 10-20% would be quite possible, if interest rates rose by perhaps 1%. In contrast, a short-term bond might only lose 1-2% for the same change in interest rates.

There are only two reasons one should consider long bonds:

1) One is fairly sure they will hold the bonds for long enough that they can recover any potential losses which can arise from drops in their price. This means you are willing to take the risk that your bonds might be worth 20% less one year from today, in order to perhaps get better long-term yields.

2) One is betting on a drop in interest rates. Long bonds can also rise in value significantly, when interest rates fall.

Unless one of these two descriptions fits you, you should simply forget about long bonds in their entirety.
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