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Investing in Long-Term Bond Funds

I have never been a fan of bond funds. Unlike a direct investment in an individual bond that you can hold to maturity and be assured you will get your principal back (assuming no default), a fund has no finite maturity date and most funds are actively traded.

Right now is an especially risky time to invest in bond funds that hold long-term bonds. With interest rates so low, we all know that sometime in the future — even if it’s not in 2012 — rates must rise. When rates rise, the longer the maturity of a bond, the bigger the decline in its price. Remember, bond prices move in the opposite direction of yields. When yields rise, prices drop.

If you own an individual bond you can at least make the decision to hold on until it matures and receive all your principal back. But a bond fund may sell bonds at those lower prices, locking in a principal loss.

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