Anticipating a jump in interest rates because of an improving economy, many investors took their money out of bond funds a year ago. This seemed logical because new bonds with higher yields diminish the value of existing lower-yielding bonds. But it was the wrong move. It turned out to be a dandy year for investing in bonds.
Federal Reserve Chairman Alan Greenspan took it nice and easy, tightening in small increments to avoid a shock to the system. Because of weak job growth and overall faith in the Fed's ability to effectively control inflation, Treasury yields remained steady, and taxable bond funds averaged a 5 percent total return. Riskier high-yield and emerging-market bond funds did even better.
Foreign investors have bought into this logic, purchasing large quantities of U.S. debt despite their reservations about the weak dollar and rising rates.
As 2005 begins, many investors are flush with the cash they pulled out of the markets last year. When buying bonds or bond funds, they're favoring five- to six-year durations.
Experts see interest rates rising this year, with the economy's path determining whether the Fed continues to nudge rates or gives them a harder push.
"Some people have been trying to predict if rising short-term rates will continue, or if they're just for a short period," said Dan Solender, portfolio manager of Nuveen Limited-Term Municipal Bond Fund in Chicago. "Everyone has been trying to figure out whether the impact of rate increases has been slowing things down."
Rates remain so low that they'll just have to go up, Solender reasons. While difficult to forecast when and how this will occur, investors shouldn't expect much upward rate movement in the short run, he said.
Bond investors should think long term, keeping holdings diversified and well-balanced. Never pull money in and out. When selecting bond funds, consider their consistency and track records. Buying several funds that emphasize different durations spreads rate risk. The longer a bond's maturity, the greater its volatility and risk.
The top-performing short-term investment-grade taxable bond funds during the past 12 months, according to Morningstar Inc., were:
Scudder PreservationPlus Income (DBPIX), $682 million in assets; "no load" (no sales charge); $500 minimum; 800-621-1048; average bond duration 0.9 years; current yield 3.79 percent; total return 6.54 percent.
Security Capital Preservation "A" (SIPAX), $154 million; 3.5 percent load; $100 minimum; 800-888-2461; duration 0.9 years; current yield 5.45 percent; total return 6.12 percent.
Metropolitan West Strategic income Fund (MWSTX), $115 million; no load; $5,000 minimum; 800-241-4671; duration 2.1 years; current yield 3.01 percent; total return 5.85 percent.
Phoenix-Goodwin Multi-Sector Short-Term Bond "A" (NARAX); $431 million; 2.25 percent load; $500 minimum; 800-243-4361; duration 3.07 years; current yield 4.45 percent; total return 4.81 percent.
Marshall Government Income Fund (MRGIX), $372 million; no load; $1,000 minimum; 800-236-8560; duration 2.7 years; current yield 4.88 percent; total return 4.24 percent.
Andrew Leckey is a Tribune Media Services columnist.