No need to jump ship
You could blow your retirement income plans, however, if you bail out of your bond funds and, temporarily, hide the money in bank CDs. You're thinking, "I'll go back into bonds when interest rates stabilize." But no one rings a bell when a rate rise is complete. You're giving up a lot of income while you wait. What's more, when you return to bonds, you'll need to capture a higher-than-average rate to make up for the income you let go. That would mean taking higher risks.
CDs and very short-term bond funds are fine for cash you need soon, but for down the road you should stay with intermediate-term funds.
To prevent apparent loss, some investors might switch to individual bonds. That gives you "emotional control," says Christopher Philips, senior investment analyst for Vanguard. You collect your full principal when the bond comes due. But you don't get the increase in income that bond funds pay. To capture part of a rising rate, you might buy a series (or "ladder") of bonds that come due in different years. But bond funds are easier to own.
Finally, remember one more ironclad law: Interest rates are unpredictable. They might rise gradually just with economic growth; or rapidly if inflation takes hold; or decline if the economy gets squashed again. For the fixed-income part of your retirement investments, a prudent allocation would include a TIPS fund plus an intermediate-term fund — say, a bond index fund or a tax-free municipal fund. Stick with high-quality bonds, Philips says. Take your risks and part of your inflation protection in stocks.
Jane Bryant Quinn is a personal finance expert and author of Making the Most of Your Money NOW. She writes regularly for AARP Bulletin.
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