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Posted: 6:00 a.m. Tuesday, June 25, 2013

Stock market jitters worry investors

Bonds may seem safe, but are they really?

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By Clark Howard


Are you among those investors who ran to bond funds for safe harbor when the stock market went topsy-turvy? Those who did so generally saw nice rewards from making the move. But there is a hidden danger that I want to make you aware of.

The Federal Reserve has signalled they're going to stop artificially holding down interest rates. When interest rates rise, the value of your bonds will fall. In some cases, the value may fall by enormous amounts. And we are a period in history when it's unlikely interest rates will do anything but go up from here.

Here's the problem: If you buy a bond fund and interest rates go up, the value of your bonds go down. Depending on what kind of bond you have, the value could go way down.

Let's say you buy a bond at 3%, and then interest rates rise and new bonds are issued at 4%. If you needed to sell your bond, you'd be forced to discount your bond to the point that the new buyer would effectively make the entire 4% interest on their money.

If you're one of the millions upon millions of Americans who got into bonds as a safe harbor, the best thing to do to reduce your risk is to trade down from long-term bonds to short-term bonds.  Go with shorter duration to protect yourself.

Meanwhile, for your short-term money, you have no choice but to go into something like CDs and simple savings. Short-term money is generally considered money you're going to need in 5 years or sooner.

Any money you won't need for at least five years -- and maybe even 10 years or more -- is best placed in the stock market, despite the market's topsy-turvy run of late.


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