How should you respond to bond market volatility?
EDWARD JONES: FINANCIAL FOCUS
SUBMITTED BY SCOTT SHANKS Edward Jones Investment Representative

Shanks

As you no doubt know, the financial markets have experienced considerable turmoil the past several weeks. If you've owned bonds in the hope that they would provide more stability to your overall portfolio, you might be somewhat concerned when you open your investment statements these days, because the prices of some bonds have fallen - and, in some cases, they've fallen sharply. So, what should you do about it? If your stocks and your bonds are going to keep you tossing and turning at night, should you just reach under the mattress and put all your money there?

Fortunately, you don't have to take such drastic steps. Still, in the short term, you might be particularly concerned about the performance of your bonds. What's caused their prices to fall? And how should your respond?

To begin with, not all bond prices have fallen. In fact, many bonds have increased in value in recent weeks. The falling prices are mostly found in bonds issued by financial services companies and bonds issued by municipalities (taxfree municipal bonds) or governmental agencies. The bonds issued by financial services firms have fallen largely due to the "credit crunch" - and an accompanying loss of confidence in the credit markets - that occurred following losses suffered in the risky subprime mortgage market. (Subprime mortgages involve making loans to borrowers who, due to poor credit histories, do not qualify for the best market interest rates.) As for the tax-free municipal bonds, their value has dropped due to a supply-demand imbalance - that is, too many bonds and too few investors for them. Keep in mind that bonds may be subject to state, local or the Alternative Minimum Tax.

So, in a nutshell, that's why many bond prices have fallen. But even a difficult environment such as this provides some good opportunities for alert investors. So, as you ponder what to do with the fixed-income side of your portfolio, consider the following:

Increased "spreads" reward patient investors. The bond market problems generally have led to an increased demand for higher-quality investment grade bonds and shorter-term bonds. This demand has pushed these bonds' prices up and rates down. (Bond rates generally move in the opposite direction to prices.) Consequently, the "spreads" - the differences in rates - between short-term bonds and long-term bonds and between lower- and higher quality bonds has increased. That means you can now receive higher returns for buying longer-maturity bonds and taking on an acceptable level of increased risk.

Price drops don't affect interest payments. Unless you were planning to sell your bonds before they mature, you have little have little reason to worry about short-term price drops. You will still receive regular interest payments on your bonds, and, barring a default by the issuer, you'll still get your principal back when your bonds mature. So, as a source of regular income and a way to help diversify your portfolio, bonds still provide you with some key benefits.

During rough markets, it's not always easy to maintain a long-term perspective and "stay the course." Yet, that's just what you need to do. If you own a well-balanced portfolio, there's no need to panic and sell your bonds. No one can predict the future, but if the past is any guide, patience and discipline will once again be the keys to working towards investment success.