Friday, December 19, 2008

Bond Fund v. Actual Bonds

The one winning investment I made this year was the purchase of a few TIPS back in late October. Because interest rates have fallen, I have made over 8% on my money in less than two months. They mature in 2013. In addition to the individual TIPS securities, I own a similar sized position in a TIPS mutual fund.

In the short term (3-6months), I do not expect the interest rate environment will materially change. For that reason, I am going to hang on to both investments through Spring. Nevertheless, I cannot imagine low interest rates will hold indefinitely and I will sell the TIPS fund sometime next year.

With respect to the TIPS fund, the value can and will fluctuate as the value of the securities in the fund change with market conditions. As rates begin to rise, the fund will begin to lose value. As a result, I have no way to accurately project what they will be worth at any given time.

While the value of the TIPS securities I own will fluctuate from time to time, I know exactly what they will be worth in 2013.

My Strategy: I will favor individual treasuries over bond funds. For no transaction cost, Fidelity will allow me to buy treasuries at auction. By holding them to maturity, I don't have to worry about fluctuating values.

I do, however, think bond funds do have some value. For securities where there is default risk (munis and corporate), good bond funds allow investors to diversify so as to prevent a default event (GM Bonds anyone?) will not be crippling.


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