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fost,

A bond fund has much more risk associated with it than most people recognize. The issue is interest rate risk. As fed dictated rates rise on the short end, bond prices will adjust across the entire yield curve. To compensate for treasury rate changes, all bond prices fall, tracking treasuries. That pushes bond fund Net Asset Values (NAVs) down as well. With an actual bond that you hold yourself, this isn't necessarily a huge problem. As long as you didn't buy above par, you can ride out the rate change and eventually collect par on maturity.

This doesn't happen as efficiently with bond funds. The reason is primarily the behavior of investors. As treasury rates rise, bond values in the secondary market fall to compensate. Holders of bond funds see the writing on the wall and SELL their shares. Fund managers don't have the luxury of holding through maturity because they face these redemptions. So, they're forced to sell bonds at a loss to raise cash to cover redemptions. That locks in losses for everyone as the funds' NAVs fall.

If you're in bond funds, you need to buy at lows and pay close attention to interest rates. That makes bond funds dangerous as buy and hold vehicles. They're really only a reasonable long term hold in a falling rate environment. In a rising rate environment like the one we SHOULD be facing, they're a risky purchase UNLESS you're dedicated to watching rates closely and getting out; i.e. they're a swing trading vehicle in this particular market.

The best thing to do with a safety fund is keep it liquid in a money market and shop for the best rate available. The rates are what they are and there's really no way to fight it. CDs are okay, but also not ideal because of their duration. If you need the cash, you may end up with a penalty to cash in the CD. Consider a credit union. Some have better rates than commercial banks. Shop around... A bond fund however, is definitely not a cash equivalent. It's an investment. It's also not a well timed one with the fed beginning to discuss its exit strategy.

Peter
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