Where to Invest Money in Bonds With $10,000 to Invest

You want to invest money in bonds in 2011 and earmark $10,000 to earn higher interest than your bank offers. Your best bond investment would be a bond fund because here you get diversification and professional management… for a price. Before you call a financial planner and rush into things, it’s best to know where to invest to get the best bond fund for your money.

If you invest $10,000 in the wrong bond fund in 2011 you could lose money in 4 different ways. First, up-front sales charges could eat up a few hundred dollars. Second, yearly fund expenses could cost you money every year to the tune of a couple hundred. Third, you could be talked into putting money into a risky bond fund. Fourth, even the best bond fund could lose money in 2011 and beyond. The first 3 money mistakes can easily be avoided.

Let’s start with the money basics. People invest in a bond fund to earn greater interest income, not to make their money grow. That’s what a stock fund is for. In the prevailing interest rate environment don’t expect more than 5% a year in interest income (dividends) for 2011 from even the best bond fund. We’ll describe the best fund later. For now focus on the 5% (or less) you might earn and the cost of investing mentioned above. A 3% to 4% sales charge and expenses of 1% to 2% the first year means that you give back your interest income for 2011. There is NO good reason to do this.

Now let’s look at the third way to lose money. Why would a securities salesman who calls himself a financial planner talk you into a riskier bond fund? He wants your money so he can make a commission. If he talks 7% or 8% vs. 3% or 4%… you are more likely to invest money with him and not pay attention to what it is costing you to invest. There are basically two ways you can earn significantly higher interest income in a bond fund, and both increase your risk. One, you can sacrifice quality. Two, you can go with a long-term fund that holds debt securities with average maturities of 20 years or more.

When you combine both lower quality and long-term maturities you get the best bond fund yields, or highest interest income potential. You also get more risk than you probably bargained for. Low quality increases the likelihood of default: interest and principal payments may not be paid by some of the issues in the bond portfolio. Long-term issues that mature in 20 or more years are the biggest risk in today’s low interest rate environment. When you invest money in a long-term bond fund you will live with higher “interest rate risk” than the best bond fund for 2011 has.

Here’s how to picture interest rate risk. A bond fund holds hundreds of debt securities and each pays a fixed interest income that never changes for the life of the security. Upon maturity interest payments stop and the owner (in this case the fund you invest money in) is paid back the principal that was borrowed. Now picture what happens to the value of these debt securities (that trade in the market like stocks do) when interest rates in general zoom upward. The price or value FALLS to adjust for the fact that higher rates are now available elsewhere. That’s interest rate risk and it applies to all marketable debt securities.

If you invest money in a fund that holds short-term maturities you won’t be greatly affected. But a bond fund that holds 20 or 25 year maturities will get clobbered when interest rates rise significantly. It’s got low interest rates locked in for many years, and the price (value) of their holdings will fall to adjust for this. If you have your $10,000 invested with them, you lose money. This is not the place to invest money in 2011, with interest rates near all-time lows.

Here’s where to invest money: the best bond fund for 2011 and beyond. You’ll cut costs, which directly increases the money you make and keep. You’ll also lower your risk. Some major no-load fund companies offer NO sales charges AND low yearly expenses. To get the best fund for you money put your $10,000 in a BOND INDEX FUND, where your total cost to invest can be less than �% a year. To keep risk moderate while earning a respectable interest income go with a medium to high quality fund that invests in corporate bonds. Go intermediate-term, with an average maturity of 5 to 7 years.

Where do you find all of the above? Go to the websites of the largest no-load fund companies: Vanguard, Fidelity, and T Rowe Price. What exactly do you want to invest your money in? The best bond fund for 2011, which is: A no-load, medium to high quality, intermediate-term, BOND INDEX FUND. When ready to invest just call the fund company of your choice toll-free and explain that you have $10,000 to invest in the above fund. They’ll gladly help you invest your money, and will give you good service in the future as well.

A retired financial planner, James Leitz has an MBA (finance) and 35 years of investing experience. For 20 years he advised individual investors, working directly with them helping them to reach their financial goals.

Jim is the author of a complete investor guide, Invest Informed, designed for average investors or would-be investors of all levels of financial background and experience. To learn more about investments and investing and his new financial guide go to http://www.investinformed.com.