(MONEY Magazine) – Q. I listen to a lot of business talk radio. Half the pundits say that this is not the time to buy bonds. The other half say everyone should own some bonds. So who's right? JOHN MIKESCH SEATTLE
A. At the risk of making things even more confusing, I'd have to say the answer is...it depends. There are really two questions here. The first is, are bonds a good moneymaking opportunity in the short term? Second, do they make sense in your overall financial plan? Over the next year or so, it may be tough to get much of a boost from bonds. Remember, the value of a typical bond falls as interest rates rise. Right now, interest rates are still near historic lows. That has surprised a lot of experts—many expected a bigger rate spike for 2004—but the fact remains that rates have more room to go up than down.
That doesn't mean bonds don't belong in your portfolio, especially if you expect you'll need some of that money within the next few years. Even now, bonds have far less potential to lose money than stocks have. In 1994, the worst year in the past decade for bonds, the average bond fund fell just 3.5%. By comparison, the S&P 500 index slipped 22% in 2002 alone.
So if you need the stability of bonds, what do you do now? If you hold individual bonds, you can shift into issues with shorter maturities to lessen the impact of any rate increase. Or you can leave these interest-rate worries to the managers of FPA New Income fund (800-982-4372), who have a great record of betting on the right bonds at the right time. Finally, rebalance your portfolio. Bonds have returned more than stocks have in recent years, so you may now have more bonds than you need.
As for pundits: If you actually hear someone on the radio telling you to dump all your bonds now, your best move is to switch to the oldies station.
Q. What role should a pension play in an asset-allocation model? Can it replace the bonds in a portfolio? TOM RUTTKAMP BELLEVUE, WASH.
A. Not exactly. If you know you will be getting a pension income, you can own fewer bonds than you otherwise would, says financial planner Gary Schatsky of Objectiveadvice.com. That's because you won't be relying so much on interest income to pay your bills. But Schatsky adds that even if your pension covers all of your living expenses, bonds are still essential to a diversified portfolio. Unlike a pension, bonds allow you to dip into principal in an emergency.
If retirement is still far off, don't spend a lot of time thinking about your pension. You can't be sure what you'll get in the end, since its value is based on such unknowns as how long you'll stay with your current employer.
Q. Are there any mutual funds that invest in generic drugs? ROBERT CUMMINGS VIA E-MAIL
A. If you just want to get into generics, forget funds. The health-sector funds that own lots of generics tend to own the brand-name drugmakers too, so they aren't a pure play. But individual generic stocks are intriguing, since as health costs rise, more of us are likely to switch from brand drugs to no-name pills. Teva Pharmaceuticals (TEVA) and Forest Laboratories (FRX) are the largest generic firms, with market values just under $20 billion. That's smaller than the typical drug company, and both stocks trade at price/earnings ratios in the high teens—expensive for a drugmaker. Consider generics an aggressive bet.