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Foreign bonds

Question: Hey Chris, I've been listening to you since the "old days" with Sound Money. Good shows. Anyway, we know that a sound portfolio should have a combination of domestic stocks, international stocks, and bonds, but what about international bonds?

I do have a Roth Euro Stock Index Fund with Vanguard and a taxable account with T Rowe Price - mutual fund with more European stocks but as I shift more funds into bonds (better asset allocation) should some of them be in international bonds. Vanguard doesn't seem to have an international bond fund where I have 3 funds. Thanks and rock on. Thomas, St Paul, MN

Answer: Cool. Thanks for listening all these years. Hmm, and since no one is in the office yet, I'll crank up the music.

Now to your question: I've never been a big fan of owning foreign bonds as part of a long-term investment strategy. Most of us invest in bonds for income and reliability, as well as diversification. That's why I favor government bonds, Treasury Inflation Protected Securities, I-bonds, blue chip corporate fixed income securities, and similar low risk fixed income securities. But when you invest in foreign bonds there is the added risk of currency fluctuations. I don't think the foreign bond interest payments are enough compensate for the risk that changes in currency values will wipe out your gains. Yet if you hedge against currency fluctuations you largely defeat the purpose of diversifying internationally. It's simpler and easier to stick with domestic fixed income securities.

By the way, you might get a nice currency kick from your exposure to European stocks if the dollar continues to fall in value relative to the Euro. That raises an intriguing speculation with foreign bonds. It's a savvy way of speculating on a falling dollar. The value of interest and principal payments denominated in a foreign currency should appreciate if the dollar continues its downward trajectory. Of course, the dollar could surprise everyone (and I lean in that direction). But this is a speculative play, not a building block of a sound portfolio.

About the author

Chris Farrell is the economics editor of Marketplace Money.
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Hi Chris, I have a follow-up question or maybe a difference in opinion. I am 33 and in my IRA, I have about 9 percent of my IRA retirement savings in a Fidelity international bond fund (New Market Income) for diversification. In this fund, about 85 percent is "U.S.-Dollar Denominated Foreign Debt, 85.5." Does this insulate the fund from foreign currency fluctuations?

For me (I will admit I am still wet-behind-the-ears) this fund has paid good dividends, and even proved to be relatively more stable than a Fidelity domestic bond fund I held, when considering the fact that it consistently yields well above 5 percent. Additionally, I even made 20 percent in capital gains in my annual re-balancing since I bought more at the bottom (during the crisis) and the price currently seems to be experiencing a bubble from people chasing higher returns. I really like the show and have been an avid listener for the last 10 years.

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