Confusing Times for Bond Investors

Go figure.

The Fed is committed to raising short-term interest rates, but long-term rates have been creeping down since early June. The yield on the 10-year note -- which peaked at 4.87% on June 14 -- fell through 4% this week for the first time since early April.

So what are individual investors to do? The experts tell us we should keep a portion of our investments in bonds to have a rock to cling to during market meltdowns like 2000-02 and 1973-74. When stocks are down 30% to 40%, boring old bonds will still be there, throwing off income.

But being a buyer of bonds in a period when the Fed is raising interest rates, as it has done three times since late June, may be asking for punishment. The price of a bond moves in the opposite direction of interest rates. For example, a $100,000, 10-year bond purchased at 4% this week will be worth about $93,000 in a year if 10-year bond rates rise to 5%.

Earlier this week, the Fed raised the federal funds rate, what banks charge one another overnight, by 0.25% for the third time this year, to 1.75%.

That means the bond you buy today, if the Fed continues to hike interest rates by year's end, will most likely be worth less in the market next year. Of course, you'll have the consolation of earning interest on your bonds, just less than what future buyers of bonds will be earning as rates rise.

Then there's the question of whether to purchase individual bonds -- such as those issued by corporations, municipalities or the federal government through the Treasury Department -- or whether to rely on bond mutual funds.

"I'm a bond expert. I don't own any individual bonds. It's too much work," says Mark Kiesel, head of the investment-grade corporate bond desk at Pimco, a leading manager of bond mutual funds, and portfolio manager of the (PBDAX Quote) Pimco Investment Grade Corporate Bond Fund.

Whether you buy individual securities or bond mutual funds, many financial advisers recommend keeping maturities -- the number of years before a bond is paid off -- short; less than five years, and preferably less than two or three years. That way, should interest rates continue to rise, when your bonds mature, you will have cash to buy bonds at the new, higher yields.