Buying Bonds in a Rising Interest Rate Environment

The Best Bond Funds in 2016 and 2017

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Learn how to choose the best bond funds in 2015. Getty Images

The Federal Reserve is gradually unwinding its stimulus as the economy moves from life support to stable condition. But bond prices move in the opposite direction as interest rates, which makes investing in bond mutual funds and ETFs a challenge, to say the least.

Finding the best bond funds in 2016, to say the least, will be a challenge. But here are some general guidelines for buying fixed income investments this year.

Best Bond Funds For Rising Interest Rates

One way to invest in bond funds during rising interest rates is to use short-term bond funds. Generally speaking, bonds with longer maturities fall further in price than those with shorter maturities. So by using bond mutual funds with shorter average maturities, you can minimize the negative effect of falling prices. In this case, investors can consider short-term bond funds.

Another way to manage uncertainty in rising interest rate environments is to use a well-diversified and well-managed bond mutual fund. One such fund is Loomis Sayles Bond (LSBRX). Manager Dan Fuss has been has 55 years of experience in the investment industry and has been with Loomis,Sayles & Company since 1976. Fixed income can be more complex and difficult to manage than stock portfolios. So a skilled and experienced manager is a must for bond fund investing. But keep in mind that LSBRX can invest in high-yield bonds, which can see steeper declines in price if the economy turns weak.

A good bond mutual fund to remain diversified is Vanguard Total Bond Market Index (VBMFX).

How to Know When to Sell Bond Funds

If bond funds are expected to fall in price in 2016 wouldn't it be wise to simply sell your bonds funds now and shift the fixed income portion of your portfolio into cash? This is a challenging question but the answer is relatively simple if you are a long-term investor.

If you look back over the past several years, you can see that stocks had one of their best positive runs in history, whereas bonds didn't do so well over the past few years, with exception of a few bright spots for bond prices.

The point here is that bond funds can lose money, which is to say that prices of bonds can fall, especially when interest rates are expected to rise.

But isn't this how diversification is supposed to work? One asset does extremely well and another asset performs below average. That's called a good balance, not a bad allocation! Also, if you are dollar-cost averaging into bond funds, you are buying shares as they fall in price. So when the prices begin to rise again, your "average" share price is lower and thus you benefit more when they bounce back.

Outlook for Bond Funds in 2016 and 2017

Here's the bottom line for buying the best bond funds in 2016, 2017, and beyond: If you want to minimize risk first and maximize returns second, which is a wise investment philosophy, you will not completely abandon your long-term outlook but simply remain diversified.

Additionally, who's to say the economy won't slow down again and bonds hold on to their values or even go up in price as stocks have low to negative returns?

No one really knows. This is why the buy-and-hold strategy tends to work best for most investors.

Disclaimer: The information on this site is provided for discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.