Question: Most investment grade short term corporate bond funds contain about 30 % financial holding in their portfolio. Would this stop you from investing 20% of your portfolio in this type of fund in retirement for income? Milton, Albuquerque, NM
Answer: Outside of the U.S. Treasury-only bond funds, a majority of funds in the bond market mutual fund category posted losses in 2008. The performance has been better in so far this year. To take one representative example, the Vanguard Short-Term Investment Grade mutual fund had a total return of -4.7% in 2008, according to Morningstar, the fund rating service. It has sported a total return of 3.13% year-to-date in 2009.
Investment-grade short-term corporate bond funds are increasingly popular. These are the debt obligations of brand-name blue-chip companies. The risk of the owning the debt is further reduced by short-term nature of the I.O.U. The yield on these funds is much better than the yield on comparable Treasuries. And you’re diversified within the corporate bond sector with a mutual fund.
Still, there is credit risk with the downturn. Some of the companies in the portfolio might be downgraded, and others could fall into financial trouble. That’s why owning a portfolio with nearly a third of the IOU’s the obligation of financial institutions gives me pause–as it does you.
A fifth of your portfolio in retirement exposed to one sector seems like a lot to me.
I imagine you want the higher income. The questions I’d be asking are: Am I being compensated enough for taking the risk? How much of my portfolio do I really want to expose to this sector? What is my downside if the economy takes another step down, inflation picks up or something else happens that affects the value of this investment? How much would a poor performance mean to me and my income in retirement?
I think the economy is doing better, thanks to a combination of fiscal stimulus, Federal Reserve policy, mortgage refinancing, TARP funds, lower inventories, and fiscal spending and monetary easing overseas. It’s one reason why more investors are feeling confident enough to put money into corporate bonds. But the economy remains fragile. My bias is to stick with financially safe investments and only take greater risks if your household balance sheet is strong enough to ride out another round of bad times. This is especially true for retirees.
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