Confusing Times for Bond Investors

Kiesel says that bond mutual funds offer several advantages for investors that make annual fund fees worthwhile. (These can range from 0.2% to 1.5% and more, which at the high end can really eat into the already-limited returns that bond funds offer.)

First, the only way to get the best bid/offer spread when buying bonds is to purchase them $1 million at a time. Anything less, says Kiesel, and you're getting the more expensive bonds from the "odd-lot" desk.

Then there's the all-important matter of diversification. If you purchase anything but Treasuries, you're buying IOUs from municipalities or corporations that just might be unable to repay. With a bond fund, you have protection through diversification.

"As an individual investor," says Kiesel, "you're not going to be able to buy 200 to 400 bonds like a fund manager."

And then, of course, there's professional management. "It's very difficult for an individual to know when rates are going to rise, what part of the yield curve to be on." (The yield curve is the line tracing the relative yields of bonds over their maturities from three months to 30 years, and it varies according to current interest rates and economic conditions.)

Jack Blankinship, CFP, is a partner in the Del Mar, Calif., firm of Blankinship & Foster and was named one of the nation's Top 100 Wealth Advisers in the Robb Report Worth's new October issue. He typically has the portfolios of his affluent clients invested 65% in stocks and 35% in bonds, mostly through mutual funds that invest in short-term Treasuries and other short-term, fixed-income investments.

He views the bond allocation as an insurance policy. "We're not looking for income from that portion," says Blankinship. "It will do its job if it just preserves capital."

While his firm had long used (PTTAX Quote)Pimco Total Return A fund, an intermediate-term investment-grade bond fund managed by Pimco founder and bond guru Bill Gross, Blankinship has recently taken most of his client money out. He believes Gross will have trouble maintaining his outstanding record (10.07% total return between 2000-02) without taking too much risk.

"I feel very comfortable with my 2.5% to 3% average annual rate of return," he says.

The bond mutual funds his firm currently uses include (PTLAX Quote) Pimco Low Duration, (VSGBX Quote) Vanguard Short-Term Federal and (MWUSX Quote) Metropolitan West Short-Term Treasuries.

Blankinship also invests in nine-month and one-year certificates of deposit.