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No. of Recommendations: 5


I'm not a fan of most band funds for extended holding periods. The way they tend to work is that while interest rates are falling you gain in principal, which is great. The problem is when interest rates are rising, the math works against us the increased interest rate doesn't adequately cover the loss in principal.

To me this means I need to work these funds not just fire and forget and assume they are safe. If I'm investing in a bond fund I'm guessing/betting that rates will decline. At some point I'll have to exit and preserve my capital gains. You are in no way bound to agree with my assumptions. I would encourage you to take a good look yourself. Part of our FAQ deals with bonds v bond funds.

A bond fund is not a bond equivalent, many sellers of bond funds suggest that they are but the math just doesn't work in our favor. In the end a bond fund or any fund makes money on having many people investing large sums in the fund and charging their management fees. What a bond fund is a company that takes your capital and invests it for you in bonds; they buy bonds, the bonds either mature or are sold, the company rinses and repeats. Their is no maturity date the fund goes on and on unless it becomes defunct for lack of capital. The result is NAV, the value of your principal, goes up and down as interest rates change.

A bond has a maturity date and as such a known steady value. If I buy a bond for $1,000 I know that I will get my interest (dividend coupons) on their schedule and I'll get my $1,000 back at maturity. During my holding period the market value may go up or may go down but, assuming they do not default, I will get my $1,000 back on the maturity date.

Do you see the difference? Its important.

With a 3 - 5 year spending horizon capital preservation is far more important than capital appreciation. Or written another way you are probably better off living with 1% interest rate while avoiding a 5% - 10% ding to principal. Still another, chasing a 5% yield that might end up with a 10% hit before or right when you need the money is probably not the best choice.

That doesn't mean you have to live with the lowest rates. What it means is that anything you shop for with better rates still needs to have adequate principal protection built in or priced in.

What are your options:
A)passbook accounts - FDIC insured piddly interest rate
B)CD's better rates but the money is locked in for a fixed period. They can be shopped for so you can find better ones then your local bank my offer
D)Short or Ultra short funds; principal is at minor risk and you may or may not outpace a carefully selected basket of CDs. They are flexible and easy to add to or withdraw from. (I suspect longer term funds may be at more risk than you would want to accept, I may be wrong)
E)Treasury products that mature between now and when you need the money. They are bought in $1,000 units so you wouldn't be able to add $500 a month. They may actually cast you a little more than $1,000 if they sold at auction above par. Or you can by them on the secondary market and maybe shop more carefully.
F)Very well researched high on the scale corporate bonds. They may pay a bit more than treasuries. For the higher return you are accepting the potential of default which needs to measured and understood before buying.

Does that help or did I just confuse things?

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