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By Christine Benz | 09-29-2010 01:38 PM

Zweig: Set the Right Expectations for Your Bonds

Investors should account for the effect of higher rates as well as moderate their return expectations, says the Wall Street Journal columnist.

Christine Benz: Hi. I'm Christine Benz for Morningstar.com. I'm joined here today by Jason Zweig. Jason is a personal finance columnist and he is also the author of several books about money and investing.

Jason, thanks so much for being here today.

Jason Zweig: Glad to be with you, Christine.

Benz: So, Jason, one topic on your mind and my mind these days is fixed-income investing and investors' attraction to any investment that promises safety right now. Can you talk about what you make of this stampede that we've seen in the bonds and bond funds over the past couple of years?

Zweig: Yeah, I think there is a couple of interesting points to make. First of all, this has really been painted in the press, of which, obviously, I'm a member, and in the public consciousness as a retail investor mania, as if mom-and-pop investors on Main Street are barging into bonds and they've lost their minds and they're going to have their heads handed to them.

I think what's getting overlooked is it's not just retail investors who are doing this; a large part of the flows into fixed income are coming from institutions. In fact, a large part of the flows are coming from sovereign wealth funds, foreign central banks, governments like China and Japan. So, if it's a mania, or above all, mom and-pop, they've got lots of company.

My main concern is that what people are buying may not be what they think they are buying. And if you are buying the trailing 12-month performance of the fixed-income market, that's great, but that may well not be what you get over the next 12 months. And certainly bond prices today are extraordinarily sensitive to any rise in interest rates, and that's the thing people have to make sure they are comfortable with. If interest rates go up, do I have a comfortable cushion in case bond prices come down, which they will if rates go up.

Benz: Right. So related question is whether standard asset allocation models that are prescribing X percent in fixed income are relying too much on the past few decades perhaps to come up with those recommended allocations and whether investors should think about questioning those asset allocation recommendations?

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