Is It Bonding Time?

August 13, 2009
Michael Sheehan

Buyers who flocked to long-term US Treasuries during the credit crisis' worst days are now being doused with red ink amid a rosier economic outlook. Even municipal bonds are looking shaky these days. So what's a bond investor to do?

In troubled times, stock market investors often head for the exits and look instead to bonds as a safe haven. When the credit crisis was in its worse days, buyers flocked to US Treasuries, sending prices on a rocket ride. As the economic picture has gotten a little rosier, however, prices on long-term Treasuries have plunged, dousing bond funds that were heavily invested in them with red ink. Municipal bonds are looking riskier too, according to Wall Street bond analysts, as shaky state and local budgets increase the chance of credit downgrades or even default.

If your financial plan includes putting some assets into bond funds, many financial advisors suggest that you check on a fund’s portfolio before investing. Steer clear of funds that have a sizeable stake in high-risk or junk bonds, since they are open to the growing risk of corporate debt default, plus they’re often victims of panic selling when the economy falters. You should also be wary of funds that are primarily invested in long-term securities. These funds are more sensitive to rising interest rates and could take a hit when the economy finally emerges from the current recession. Some analysts believe that funds that invest in intermediate-term corporate and government bonds securities may be a better choice.

With gains going lower and risk on the increase, one way to invest in bonds is through a fund that tracks binds in a benchmark index like the Barclays US Aggregate Bond Index. Because an index fund tracks the broad bond market, there’s no chance that the fund manager will take a flyer on an investment that goes sour. Index funds also have lower expense ratios, an important factor when returns get paper-thin.