Bonds a worthwhile investment – any time

Many investors who have not reached retirement age pay little attention to the income side of their portfolio.

That’s a fundamental mistake – one which has been become glaringly apparent during the prolonged bear market. If you look closely at mutual fund performance numbers over the past three years, you’ll see that a diversified portfolio that included a significant percentage of income-oriented funds would have fared much better than one which was heavily weighted towards stocks.

The following table shows the average annual three-year compound rates of return for the period from the beginning of 2000 to the end of 2002 for several key fund categories, as published by The Globe and Mail.

&l;T>Canadian equity funds

Income trusts funds	+12.7 per cent
Foreign bond funds	+ 7.8 per cent
Canadian bond funds	+ 6.7 per cent
Canadian balanced funds	+ 0.3 per cent
– 2.2 per cent
Global equity funds	– 12.2 per cent
U.S. equity funds	– 13.8 per cent

This pattern won’t always hold true, of course. When stock markets finally recover, the equity funds will again be stars and the bond and income funds will pull down overall returns. But over time, these cycles even out. A well-balanced portfolio will insulate you against the periodic stock market plunges and will provide steady long-term growth.

Sacrifice very little return potential
Consider this startling fact: over the past 20 years, the average Canadian bond fund returned 9.4 per cent annually. The average Canadian equity fund returned 9.6 per cent. The conclusion: you sacrifice very little return potential over the long term by including a higher percentage of bonds in your asset mix, and you greatly increase your personal comfort level by reducing your risk exposure in tough times.

Next page: But isn’t this a bad time?

But isn’t this a bad time to be investing in bonds, with interest rates near 40-year lows and all the experts saying they will likely rise later this year? Certainly, it would be better to build your income funds at a time when rates are high and expected to fall. But no one can predict those movements with certainty. A year ago at this time, the conventional wisdom was that the stock market would rebound in 2002, that rates would rise, and that bond prices would plunge. In fact, the opposite happened.

Don’t try to time the markets
We’re always being told not to try to time the stock markets. The same holds true for bond markets. The only sensible approach for an investor is to decide on a long-term strategy and stick with it. That doesn’t mean that you should never make changes. But it does mean that you should maintain a reasonable balance between income and growth securities at all times.

One fund that is worth a close look when you review the income side of your portfolio is the TD Real Return Bond Fund. It is the only fund of its type that invests entirely in inflation-indexed (real return) bonds.

Currently, the entire portfolio of this fund is in Canadian issues although the mandate permits the managers to hold up to 20 per cent in foreign bonds. Returns have been very good recently,

Both the principal and the interest of real return bonds are protected against increases in inflation. That makes them especially attractive at times when inflation is high, as it has been recently (3.9 per cent annualized as of the end of December). This fund has been reaping the benefits, with a gain of almost 15 per cent in the year to Jan. 31 and a three-year average annual compound rate of return of 9.6 per cent. Distributions are paid quarterly.

This is a no-load fund and units are available through all branches of TD Bank and Canada Trust.

Adapted from an article that originally appeared in Mutual Funds Update, a monthly newsletter that provides guidance on fund selection and portfolio building. For details about a three-month trial subscription for only $9.97 plus tax, go to http://www.buildingwealth.ca/promotion/50plusproducts.htm