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Bond Funds May See Meager Results

Stocks in this article: EKSAX

NEW YORK ( TheStreet) -- Worried about budget uncertainties in Washington and debt problems in Europe, investors have been seeking safety in bond funds. During the first six months of this year, inflows into taxable bond funds totaled $92 billion, according to Morningstar. Should you join the crowd that is rushing into bonds? Probably not. Chances are that bond funds will deliver puny returns in coming years.

To size up the outlook for bonds, consider a forecasting method long promoted by John Bogle, founder of Vanguard Group. According to Bogle, total returns in the coming decade should about equal the current bond yield. He says that the system works because most of bond returns come from the yield. If Bogle is right, the annual return of bonds will be about 2.9%, which is the current yield on 10-year Treasuries.

Although Bogle's system may seem simple, it has proved remarkably accurate in the past. In January 2000, Treasuries yielded 6.5%. During the next 10 years intermediate government bonds returned 6.2% annually, according to Ibbotson Associates. The system even worked during the 1970s, a time of roaring inflation and rising interest rates. At the beginning of the decade, Treasuries yielded 7.8%, and intermediate government securities returned 7% during the coming 10 years.

Some investors worry that bonds could do even worse than Bogle's system suggests. Recalling the years of high inflation, the bears worry that bond funds could lose money. When rates rise, bond prices fall. And many economists figure that interest rates will rise as the economy recovers. Could bond funds finish in the red for years to come?

Probably not. Since 1926, there have only been nine years when intermediate government bonds lost money, according to Ibbotson Associates. Bonds have never suffered more than two losing years in a row.

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