Where to Start Looking for Bond Investments

Thinking of making or increasing an investment in bonds?

For most investors hunting for bonds, the first place to look is in your company-sponsored 401(k) savings plan, if you have one. Many 401(k) plans offer at least one bond investment option.

If you don’t have a 401(k) and you have a limited sum to invest, buying bond mutual funds for an individual retirement account or for a regular taxable account is the easiest way to get into bonds.

Not only are bond funds professionally managed, but they also tend to have low minimum initial investments (often $1,000 to $3,000).

But as the accompanying chart shows, many bond funds are losing money year to date. Why? Because a fixed-rate bond’s price moves in the opposite direction of market interest rates. When rates fall, the price of older bonds that carry higher fixed yields rises.

But when market rates go up, as they’ve been doing so far this year, older bonds fall in value because their yields aren’t as rich as what investors can find in new bonds.

So the interest a bond fund pays can be offset by a drop in your share value in times of rising rates. That’s the concept of “total return:” You still earn the interest--but your shares may depreciate.

The good news in rising rates, of course, is that new buyers of bonds and bond funds can pick up much more attractive yields than they could even a few months before. What’s more, even though bond funds can lose value, most high-quality bond funds still offer much more stability of principal than stock funds.

The question is: Which bond funds to own? According to fund tracker Morningstar Inc., there are more than 4,000 bond funds to choose from.

The accompanying chart shows some of Morningstar’s most highly rated funds among high-yield “junk” bond funds, high-quality corporate bond funds and government bond funds. Each fund shown has a track record of at least 10 years, and has managed to beat the majority of its peers over the last one, three, five and 10 years.

The 10-year period is important because it includes all of 1994, when 93% of all bond funds posted negative total returns as the Federal Reserve doubled short-term interest rates.

In addition, each of these funds is managed by the same person or team that led it back in 1994, so you know these funds’ managers have experience in both bad times and good.

Finally, each fund is considered above average when it comes to returns and below average when it comes to risk, according to Morningstar’s proprietary fund rating system.