Confusing Times for Bond Investors

While bond mutual funds make sense for most people who are too busy to research and monitor a portfolio of individual bonds, some investors like to do just that, often with the help of a qualified broker. While they won't get the purchase price breaks and the diversification of a mutual fund, individual investors also won't have to pay an annual mutual fund fee after the initial broker's commission (typically 0.125% to 0.50%).

And if individual investors stick to an important rule of bond investing, they shouldn't get whipsawed by interest rate fluctuations as mutual fund investors sometimes do. The rule? Invest in a maturity that matches your need for the money.

If you need the money in five years, don't invest in a 10-year bond. In five years when you want to sell it, rates could be on the rise and your $10,000 could be worth only $9,000. But if you can wait for 10 years, and your borrower can repay, you will get your full $10,000 back, as well as the interest along the way.

It's also important to remember that short-term bonds pay less interest because investors are taking less risk than those who lend long term. They also fluctuate less in price than longer-term bonds.

Blankinship says this is a frustrating time for all investors. With the Fed tightening the monetary policy after a period of record interest rate lows, both stocks and bonds are faring poorly.

Expect overall returns of 5% to 8%, he cautions his clients, because stocks remain overvalued.

"You necessarily have to prune the tree," he says. After 20%-plus returns in the stock market in the late 1990s, he says, "Some people call it reversion to the mean, or whatever."

Kiesel of Pimco says his firm is looking to bonds outside the U.S. for better performance and he recommends that investors consider bond funds with a global reach. Two such funds are (PAIIX Quote)PIMCO Global Bond II A and (PFOAX Quote)Pimco Foreign Bond A.