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Investing Specialists

The Folly of Predicting the Direction of Interest Rates (and Almost Anything Else)

The past five years are a good illustration of how acting on conventional wisdom can go wrong.

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In early 2010, I wrote an article called "Don't Get Burned by Your Bonds." It was rooted in a common-sense premise. After three decades of declining yields, it seemed that "the easy money" in bonds had been made. Interest rates were apt to go higher at some point, and what had worked well for investors in the past--namely, being willing to take on interest-rate risk--could work against them in the future. The article went on to share some ideas about how to proceed in such an environment, including delegating to an active core bond fund manager and buying dividend-paying stocks with a portion of assets that might otherwise go to bonds.

Some of those recommendations panned out just fine and make sense to me today. I recommended using an active bond fund to navigate what was sure to be a tricky bond market, and three of the four funds on my short list-- Dodge & Cox Income (DODIX),  Metropolitan West Total Return Bond (MWTRX), and  Loomis Sayles Bond (LSBDX)--have performed well over the subsequent five years. ( Harbor Bond (HABDX) has lagged the intermediate-term bond category average and the Barclays Aggregate Index over the past five years, but its shortfall has been small.) And dividend-paying stocks have far outpaced bonds over the past five years. I also suggested that investors avoid taking too much interest-rate risk with assets they expect to spend within the next five years. I'd make that point any time--not just in a period in which rising rates were a threat.

Christine Benz does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.