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Fidelity Bond Funds for Cautious Investors

NEW YORK ( TheStreet) -- Plenty of investors are worried that interest rates will rise in coming years. That could be bad news for bond funds. When rates rise, bond prices tend to fall. So investors in bond funds can't be sure how much money they will have on any particular date.

To help reduce the uncertainty, Fidelity Investments recently introduced four municipal funds that target specific dates, ranging from 2015 to 2021. The funds hold bonds that mature near the target dates. The idea is that shareholders will receive their principal back on the target dates.

The funds could be attractive for cautious investors who are saving for specific events. Say you will need to make college tuition payments in 10 years. You could invest in Fidelity Municipal Income 2021 (FOCFX).

Chances are you will get your principal back on the maturity date, and until then, you receive regular interest payments. In contrast, a conventional municipal fund could tank the year before the student enters college, leaving the family to scramble for cash. For ETF investors, iShares offers a series of passive target-maturity municipal funds, including iShares 2012 S&P AMT-Free Municipal Series (MUAA).

Should you sell your traditional bond funds and switch to the new target funds? Not necessarily. The traditional funds could produce higher total returns. Consider Fidelity Municipal Income (FHGIX), a conventional mutual fund. During the past ten years, the traditional Fidelity fund returned 4.9% annually, outdoing 94% of its competitors, according to Morningstar.

The fund achieved the strong results by actively trading, emphasizing long bonds some years and other times buying shorter issues. The ability to trade gives the traditional fund an advantage over Fidelity's target-maturity funds. Those don't have much flexibility to outperform because they must hold only bonds that mature in the same year. Still, a target fund could be the better choice for someone who absolutely needs a fixed amount of money on a particular date.

The future total returns of the iShares funds should be fairly predictable. During their terms, the target-maturity funds should deliver total returns that are about equal to their yields. The yield on iShares 2017 is 2.35%, and the total return is likely to about equal the yield. The final results could vary somewhat for the Fidelity funds.
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