BOND FUNDS

For those of you who struggle with deciding upon which funds to choose for your 401K, I will be reviewing all of the different categories of funds available to 401K investors.  Today, I will be focusing on one of the common 401k investing options - bond funds.

Bond funds invest in individual bonds.  Bonds are debt instruments or loans.  These loans are typically issued by governments or corporations.  Bonds carry a fixed interest rate and a specific term. 

A 10-year treasury bond issued by the federal government currently pays 4.1% interest and the term would have a ten year term.  10-year corporate bonds issued by specific companies currently pay around 5.3% in interest.  Corporate bonds are graded based on the quality of the issuing company.  Lower rated bonds pay higher interest rates.

A bond fund typically invests in hundreds of individual bonds just like a stock fund might own hundreds of individual stocks. 

Bond funds often have a particular strategy that dictates the kinds of bonds they invest in.  For example, some bond funds only invest in short-term bonds (less than one year in duration) or long-term bonds (ten year plus durations).  Some bond funds only invest in government bonds.  Some bond funds only invest in high quality corporate bonds. 

Bonds or fixed income assets are supposed to provide a predictable return and a measure of safety.  The main reason to be in “safe” assets (cash, money market funds, bonds, etc.) is due to the risk of losing money in other asset classes like stocks and commodities.

Since the stock market always has a risk of losing value in the short term, you are advised by the investment industry to keep a portion of your long-term investments in bonds or fixed income products.  One problem with that approach is that bonds can and do lose money.  In 2022, bonds lost roughly 15% of their value due to an increase in interest rates.  When interest rates rise, the value of bonds go down. 

Bonds did provide some protection against losses in the dot-com crash in 2001, but they did not provide any protection in the financial collapse of 2008 or in 2022.  So using bonds as a measure of safety only worked in one of the last three prolonged bear markets.

Bonds always underperform stocks in bull markets.  From 2012 through 2021, the S&P 500 grew by an average of 15.7% per year while the typical bond fund only generated average annual returns of about 3% per year.  Every dollar invested in bonds cost you dearly. 

The table below will show you why I am not a fan of people owning bonds in their 401K or IRA.  The best stock index funds like the ones shown below will outperform bonds over the long-term.  Every dollar invested in bonds will cost you anywhere from 6% to 10% per year over your working life.  These lower returns will dramatically decrease your retirement nest egg. 

There are some special situations where bonds make sense. If you are in retirement or near retirement, bonds can play a role in your portfolio. 

If you have bonds or target date funds in your 401K account right now, we can show you exactly how to reposition your investments to rescue your retirement.  Email me at phil@beyondbuyhold.com with a subject line of “401K Instant Fix” and we’ll get you straightened out immediately. 

Happy Investing,

Phil

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Investing in the financial products discussed in the Newsletter involves risk. Trading in such securities can result in immediate and substantial losses of the capital invested. Past performance is not necessarily indicative of future results. Actual results will vary widely given a variety of factors such as experience, skill, risk mitigation practices, and market dynamics.