After Monday's bond-market dive, some financial advisers think it is time for bond-fund investors to batten down the hatches.
Long-term bond mutual funds have soared 18 percent this year through November, counting price gains. Intermediate-term funds have leapt 14.73 percent. Even the normally plodding short-term funds jumped 9.45 percent, says Morningstar Inc., a Chicago mutual-fund researcher.Why get greedy?
Investors who stuck out their necks and bought longer-term holdings during the year may be wise to start looking for less-risky investments in coming months, many advisers say.
"It's not a bad idea to lock in some profits and shorten up the maturities in the portfolios," says Ron Roge, a Centereach, N.Y., financial planner. But for tax reasons, some people may want to wait till January to shuffle things around.
First, consider what types of bonds your funds are holding. See if you are invested in more long-term bonds than you would like.
Interest rates already have fallen a lot. And the longer your bonds have until repayment, the harder they will get hit by any interest-rate increases. Upon taking a close look at mutual-fund holdings, "many people will find they are out longer than they realize," says Kaycee Krysty, president of Tyee Asset Strategies in Seattle.
If you are in 30-year-bond funds, some fund watchers believe that a better idea right now might be the "intermediate" realm, typically defined as five to seven years. "If you're scared, that would be a nice vehicle to move into" for greater stability, says Heather Landon, a fixed-income portfolio manager with T. Rowe Price Associates in Baltimore.
Bonds maturing in eight to 10 years are a better bet than 30-years now, says Steve Janachowski, a partner with San Francisco investment advisers Brouwer & Jana-chow-ski. "I don't believe you get paid for the risk of going into long-term bonds," he says. He recommends Harbor Bond fund; Dodge & Cox Income fund; and Vanguard's Total Bond Market index fund.
Long-term bond funds lately have been yielding about 5.78 percent and intermediate-term funds 5.42 percent, Morningstar says. Meanwhile, short-term funds are hovering around 5.18 percent, based on the past month of data.
Mark Wright, a Morningstar fixed-income analyst, also recommends Vanguard Group's intermediate-term corporate-bond fund, recently yielding 6.26 percent. A major reason is Vanguard's emphasis on low annual fees, he says, for with bonds "so much of the relative performance is determined by expenses" rather than bond-picking ability.
As an alternative for investors in high tax brackets, intermediate-term municipal-bond funds are good deals right now at their recent 3.98 percent yields, some advisers say. Investors have shunned these funds out of fear that if Congress implements a broad-ranging flat tax, bonds whose main appeal is that they aren't subject to federal or perhaps state taxes will no longer be appealing. Long-term muni funds lately have been yielding 4.55 percent.
"Munis are really cheap," says Wright, who says not many advisers think the flat-tax fear will become a reality. "After tax, most people are going to do much better in muni-bond funds now."
For investors who want fixed-income funds but would like to be a little more adventurous, Roge suggests the Fidelity Convertible Securities fund. The fund buys bonds that are convertible into stocks, capturing both appreciation and income. "You get a much higher yield than you would owning stock," he says, "And because of the yield, the prices of the securities in that fund tend to hold up well" when regular stocks drop, he adds.
He also suggests Lindner Dividend, which invests in a diverse mix of income-producing stocks and bonds. "If you're tired of trying to time interest rates, these are the kind of funds you can get into," says Roge.
But not all advisers think now is the time to pull in your horns. Many predict that interest rates could drop even further in coming months, which would lift the price of long-term bonds.
J. Michael Martin, president of Financial Advantage Inc. in Columbia, Md., envisions low inflation and lower interest rates in 1996. That will push more people into longer-term bonds in a search for yield, he says, turning in a tidy price appreciation for long-term bond investors. "Long-term bonds are on sale unless the expectation of inflation goes up," he argues. He recommends the Loomis Sayles Bond fund, which he says researches and buys unusual bonds, like foreign sovereign debt and debt of companies that may soon get a credit upgrade. "It's a very creative actively managed bond fund," he says.
For tax-deferred accounts such as Individual Retirement Accounts, Martin even recommends the highly volatile Benham Target funds, which invest in zero-coupon bonds maturing in 2000 and future years. "If rates drop, a zero-coupon bond will appreciate much more than a interest-bearing Treasury," he says. But if interest rates rise, zero-coupon bonds lose money at a much faster clip than other bonds.
In any case, people planning to lock in some of 1995 bond gains should wait until 1996, advisers say. For one thing, if interest rates do trend down as many expect, you'll capture some of the benefit. "If you feel you must get out, I wouldn't do it all at once. I would spread it out in several moves," says Ms. Landon. "There might be a lot more upside to go."
That strategy also would be wise if Congress lowers the long-term capital-gains tax rate to half investors' normal tax rate. Many advisers believe the effective date of any rate reduction will be Jan. 1.