The prospect of high turnover is one argument against getting into a bond fund today. Following a stampede into bond funds can backfire when the stampede heads out.
According to the Investment Company Institute, a national association of investment companies, bond funds have experienced a steady influx of billions of dollars per month since January 2009, while money has steadily trickled out of equity funds.
When inflation, and therefore interest rate, expectations change, "the market is going to anticipate the change," says Larkin. "The money that is in the bond market is scared money. It's worried about losing money and apt to flee."
When bond fund investors flee en masse, fund managers without an adequate reserve of cash must sell bonds to meet redemptions.
"If you're in a corporate bond fund that is having large redemptions, that means they're selling bonds at not-attractive rates when the market turns against them," he says.
Diversified approach to reduce risk
As is the case with equities, trying to time the bond market doesn't always work in favor of investors. One stress-free way to get into the bond market is with dollar-cost averaging and a diversified strategy.Bonds with long maturities are more impacted by rising interest rates than short-term bonds. To reduce interest rate risk, Robert Laura, partner at Synergos Financial Group in Howell, Mich., recommends funds with maturities of less than three years.
"Since we don't know what is going to happen, we've been playing all the angles," Laura says. "We'll go with a high-yield bond fund because if interest rates don't move for two years, it's a great place to be and you're earning a great yield. There has been a lot of discussion about a bond bubble, but bonds in general and high yield bond funds are doing well because interest rates have stayed so low."
Laura says he also includes Treasury Inflation-Protected Securities bond funds in case rates do rise and inflation sprouts up.
Whatever strategy an investor chooses, the universe of bond funds is huge, so investors without the means or motivation to buy individual bonds have much to choose from.
Bill Larkin recommends investors explore multisector bond funds in the current environment. These funds typically invest in different types of bonds as well as varying maturities.
"I call it unrestricted investment objective. They're going to be zigging and zagging, trying to find value. People always forget that the bond market is vast and there is always a part of it on sale -- you just have to find the right parts," Larkin says.
In this challenging economic environment, paying investment professionals to find the best bonds can be worth the cost, whether that means buying a bond fund or enlisting the services of a good financial adviser.
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