Bond Bubble 2011 – Your Best Bond Fund Investment Strategy

Bond Bubble 2011 – Your Best Bond Fund Investment Strategy

Just in case Chicken Little is right and there is a bond bubble that deflates in 2011, what’s your best bond fund investment strategy in regard to these income funds, which you probably own or are considering? If this so-called bond bubble bursts, even the best bond fund of yesteryear could make you feel like the sky is falling if you don’t have a sound investment strategy in place to deal with it. Here are some investment ideas for average investors.

The best investment strategy is everything if bonds unravel in 2011 or beyond and you are a typical investor in mutual funds in an IRA, 401k, or other account. That’s because most people steered clear of riskier investments like stock funds after the financial crisis. Many invested in the best bond fund they could find – one that paid the most interest. Well, yesterday’s best income fund is today’s fund to avoid if interest rates go up, so here’s your best investment strategy going forward.

Cut back on bond funds (also called INCOME funds) in general in 2011. Bond prices are high by historical standards and could go into a freefall if investors start selling these securities and the shares of the mutual funds that invest in them. That’s what happens when a bubble deflates – prices (value) fall. Your best investment strategy for the money you free up: high-quality equity-income (stock) funds that pay dividends of 2% to 3%, and money market funds. Many income funds pay less than 3% in dividends. Money funds should earn increasingly higher interest income as bond fund prices fall and interest rates go up.

The best investment strategy for the money you keep in bond funds: go with short-term and intermediate-term funds equally and avoid long-term funds. The latter will get clobbered when the bond bubble deflates and investor selling accelerates. Don’t go with the highest or best quality funds that invest heavily in U.S. Treasury bonds and notes. These pay less interest because they are backed by the government. But they are in the same boat as other income funds if the bond bubble deflates and interest rates rise. Go with high to medium quality funds for the extra interest income.

Keeping the cost of investing low will be a major part of the best bond fund investment strategy for 2011 and beyond. You’re not trying to get rich in an income fund. You are trying to get higher interest income at a moderate level of risk. Why pay sales charges and high expenses? That’s like riding in a leaky boat, and only takes money out of your account. Invest cheap with bond INDEX funds from either of the two largest fund companies in America: Vanguard and Fidelity. They offer broad diversification and very low yearly expenses, with NO SALES CHARGES to buy or sell.

If you are willing to be proactive in 2011 and beyond, here’s a technique to add to make our best bond fund investment strategy even better. You’ve got a pool of money in your money market fund and some in an intermediate-term income fund. Tell your fund company to automatically move the same amount of money each month, from the money fund to buy shares in the income fund, so that in about three years you will have equal amounts in both. The advantage of this investment strategy: if the bond bubble deflates in 2011 and for a couple more years, you will be buying more and more bond fund shares as the fund price falls. This is called dollar cost averaging and it spreads out your risk. Plus, it lowers your average cost per share.

Your best bond fund investment strategy for 2011 and beyond: cut your general exposure to income funds; go with shorter-term quality (not the highest) funds, lower costs with index funds, and dollar cost average back into intermediate-term funds. The bond bubble may or may not deflate significantly. If it does millions of average investors will take it on the chin and wonder what happened. With the best investment strategy, you shouldn’t be one of them.

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