Mutual Funds Notes/Topics Asset Allocation and Model Portfolios in MF

Asset allocation is about allocating money between equity, debt and money market segments. Asset allocation varies from investor to another depending on their situation, financial goals and risk appetite. A model portfolio creates an ideal approach for the investors situation and is a sensible way to invest. The asset allocation for an investor will depend on his life cycle and wealth cycle. Investors can have two strategies :

o Fixed asset allocation. o Flexible asset allocation. Fixed asset allocation means.

o Maintaining the same ratio between various components of the portfolio. o Re-balancing the portfolio in a disciplined manner. Fixed allocation means periodical review and returning to the original allocation. If equity is going up, such investors would book profits. They are disciplined. Flexible allocation means allowing the portfolios profits to run, without blocking them. If equity market appreciates, flexible asset allocation will result in hither percentage in equity than in debt. Bogle recommends that age, risk profile and preferences have to be combined in asset allocation.

o Older investors in distribution phase 50% equity; 50% debt. o Younger investors in distribution phase 60% equity; 40% debt. o Older investors in accumulation phase 70% equity; 30% debt. o Younger investors in accumulation phase 80% equity; 20% debt. Steps in developing a model portfolio for the investors:

o Develop long term goals. o Determine asset allocation o Determine sector distribution. o Select specific fund schemes for investment. Jacobs Model Portfolios.

o Accumulation phase. Diversified equity: 65 80% Income and gilt funds: 15 30% Liquid funds: 5% o Distribution phase Diversified equity: 15 30% Income and gilt funds: 65 80% Liquid funds: 5%

The Pros And Cons Of Money Market Funds

March 30 2011| Filed Under Federal Deposit Insurance Corporation, Government Bond, Money Market, Mutual Funds, T-bills

Money market investing carries a low single-digit return, and when compared to stocks or corporate debt issues, the risk to principal is generally quite low. However, there are a number of positives and negatives that all investors should be aware of when it comes to the money market. In this article, we'll take a look at these ups and downs, and show you how the downs can greatly outweigh the ups. (To learn about money market basics, see Introduction To Money Market Mutual Funds.) TUTORIAL: Investing In The Money Market The Positives

1. A Great Place to Park Money When the stock market is extremely volatile and investors aren't sure where to invest their money, the money market can be a terrific safe haven. Why? As stated above, money market accounts and funds are often considered to have less risk than their stock and bond counterparts. That is because these types of funds typically invest in low-risk vehicles such as certificates of deposit (CDs),Treasury bills (T-bills) and shortterm commercial paper. In addition, the money market often generates a low single-digit return for investors, which in a down market can still be quite attractive. (To learn more about investing in market downturns, see Recession-Proof Your Portfolio.) 2. Liquidity Isn't Usually an Issue Money market funds don't generally invest in securities that trade minuscule volumes or that tend to have little following. Rather, they generally trade in entities and/or securities that are in fairly high demand (such as T-bills). This means that they tend to be more liquid, and that investors can buy into them and sell them with comparative ease. Contrast this to, say, shares of a mid-cap biotech company. In some cases those shares may be highly liquid, but in most the audience is probably very limited. This means that getting into and out of such an investment could be difficult if the market were in a tailspin. The Negatives 1. Purchasing Power Can Suffer

If an investor is generating a 3% return in their money market account, but inflation is humming along at 4%, the investor is essentially losing purchasing power each year. Over time, money market investing can actually make a person poorer in the sense that the dollars they earn may not keep pace with the rising cost of living. 2. Expenses Can Take a Toll When investors are earning 2% or 3% in a money market account, even small annual fees can eat up a substantial chunk of the profit. This may make it even more difficult for money market investors to keep pace with inflation. Try Currency Trading Risk-Free at FOREX.com Depending on the account or fund, fees can vary in their negative impact on returns. If, for example, an individual maintains $5,000 in a money market account that yields 3% annually with his or her broker, and the individual is charged $30 in fees, the total return can be impacted quite dramatically. $5,000 x 3% = $150 total yield $150 - $30 in fees = $120 profit

The $30 in fees represents 20% of the total yield, a large deduction that considerably reduces the final profit. Note that the above amount also does not factor in any tax liabilities that may be generated if the transaction were to take place outside of a retirement account. 3. FDIC Insurance Net May Not Be There Money funds purchased at a bank are typically insured by the Federal Deposit Insurance Corporation(FDIC) for up to $100,000 per depositor, according to Care One Credit Counseling. However, money market mutual funds are not usually government insured. This means that although money market mutual funds may still be considered a comparatively safe place to invest money, there is still an element of risk that all investors should be aware of. (To learn more, read Are My Investments Insured Against Loss?) If an investor were to maintain a $20,000 money market account with a bank and the bank were to go belly up, the investor would likely be made whole again through this insurance coverage. Conversely, if a fund were to do the same thing, the investor may not be made whole again - at least not by the federal government. 4. Returns May Vary While money market funds generally invest in government securities and other vehicles that are considered comparatively safe, they may also take some risks in order to obtain higher yields for their investors. So, in order to try to capture another tenth of a percentage point of return, it may invest in bonds or commercial paper that carry additional risk.

The point is that investing in the highest-yielding money market fund may not always be the smartest idea given the additional risk. Remember, the return a fund has posted in a previous year is not necessarily an indication of what it may generate in a future year. It's also important to note that the alternative to the money market may not be desirable in some market situations either. For example, having dividends or proceeds from a stock sale sent directly to you (the investor) may not allow you to capture the same rate of return. In addition, reinvesting dividends in equities may only exacerbate return problems in a down market. 5. Opportunity Lost Over time, common stocks have returned about 8-10% on average - counting recessionary periods. By investing in a money market mutual fund, which may often yield just 2% or 3%, the investor may be missing out on an opportunity for a better rate of return. This can have a tremendous impact on an individual's ability to build wealth. The Bottom Line Money market investing can be a very advantageous thing to do. However, before investing any money in a money market mutual fund, investors should first understand both the pros and the cons. Depending on your individual investment and where the market is heading, these accounts could make or break your retirement.

SEBI to appoint Self Regulatory Organisation soon India Infoline News Service/ 15:58 , Oct 09, 2013 However, no specific time-frame is provided for the same. Market regulator SEBI (Securities and Exchange Board of India) will soon appoint a Self Regulatory Organisation (SRO) for mutual fund distributors, according to a media report. However, no specific time-frame is provided for the same. SEBI will select one of three entities as SRO. The three organizations include Institute of Mutual Fund Intermediaries (IMFI), Organisation of Financial Distributors (OFD) and Financial Planning Standards Board India (FPSB), the report added. An SRO means an organisation of intermediaries which represents a particular segment of securities market and which is duly recognised by SEBI but excludes a stock exchange. An SRO is responsible for investor protection and education of investors and ensures observance of securities laws by its members. The members of SRO have to follow a standard code of conduct. An SRO conducts inspection and audit of its members on regular basis through independent auditors. An SRO must work in utmost good faith and must comply with the norms of corporate governance as applicable to listed companies.

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5 Basic Things To Know About Bonds

December 19 2010| Filed Under Bonds, Credit Ratings, Portfolio Management, Risk Management Want to improve your portfolio's risk/return profile? Adding bonds creates a more balanced portfolio, strengthening diversification and calming volatility. You can get your start in bond investing by learning a few basic bond market terms. On the surface, the bond market may seem unfamiliar, even to experienced stock investors. Many investors make only passing ventures into bonds because they are confused by the apparent complexity of the market. Bonds are actually very simple debt instruments, if you understand the terminology. Let's take a look at that terminology now. Tutorial: Bond Basics 1. Basic Bond Characteristics A bond is simply a type of loan taken out by companies. Investors lend a company money when they buy its bonds. In exchange, the company pays an interest "coupon" at predetermined intervals (usually annually or semiannually) and returns the principal on the maturity date, ending the loan. Unlike stocks, bonds can vary significantly based on the terms of the bond's indenture, a legal document outlining the characteristics of the bond. Because each bond issue is different, it is important to understand the precise terms before investing. In particular, there are six important features to look for when considering a bond.

Watch: Understanding Bonds Maturity The maturity date of a bond is the date when the principal, or par, amount of the bond will be paid to investors, and the company's bond obligation will end. Secured/Unsecured A bond can be secured or unsecured. Unsecured bonds are calleddebentures; their interest payments and return of principal are guaranteed only by the credit of the issuing company. If the company fails, you may get little of your investment back. On the other hand, a secured bond is a bond in which specific assets are pledged to bondholders if the company cannot repay the obligation. Liquidation Preference

When a firm goes bankrupt, it pays money back to investors in a particular order as it liquidates. After a firm has sold off all of its assets, it begins to pay out to investors. Senior debt is paid first, then junior (subordinated) debt, and stockholders get whatever is left over. (To learn more, read An Overview of Corporate Bankruptcy.) Coupon The coupon amount is the amount of interest paid to bondholders, normally on an annual or semiannual basis. Tax Status While the majority of corporate bonds are taxable investments, there are some government andmunicipal bonds that are tax exempt, meaning that income and capital gains realized on the bonds are not subject to the usual state and federal taxation. (To learn more, read The Basics of Municipal Bonds.) Because investors do not have to pay taxes on returns, tax-exempt bonds will have lower interest than equivalent taxable bonds. An investor must calculate the tax-equivalent yield to compare the return with that of taxable instruments. Callability Some bonds can be paid off by an issuer before maturity. If a bond has a call provision, it may be paid off at earlier dates, at the option of the company, usually at a slight premium to par. (To learn more, read Callable Bonds: Leading A Double Life.) 2. Risks of Bonds Credit/Default Risk Credit or default risk is the risk that interest and principal payments due on the obligation will not be made as required. (To learn more, read Corporate Bonds: An Introduction To Credit Risk.) Prepayment Risk Prepayment risk is the risk that a given bond issue will be paid off earlier than expected, normally through a call provision. This can be bad news for investors, because the company only has an incentive to repay the obligation early when interest rates have declined substantially. Instead of continuing to hold a high interest investment, investors are left to reinvest funds in a lower interest rate environment. Interest Rate Risk Interest rate risk is the risk that interest rates will change significantly from what the investor expected. If interest rates significantly decline, the investor faces

the possibility of prepayment. If interest rates increase, the investor will be stuck with an instrument yielding below market rates. The greater the time to maturity, the greater the interest rate risk an investor bears, because it is harder to predict market developments farther out into the future. (To learn more, read Managing Interest Rate Risk.) 3. Bond Ratings Agencies The most commonly cited bond rating agencies are Standard & Poor's, Moody's and Fitch. These agencies rate a company's ability to repay its obligations. Ratings range from 'AAA' to 'Aaa' for "high grade" issues very likely to be repaid to 'D' for issues that are in currently in default. Bonds rated 'BBB' to 'Baa' or above are called "investment grade"; this means that they are unlikely to default and tend to remain stable investments. Bonds rated 'BB' to 'Ba' or below are called "junk bonds", which means that default is more likely, and they are thus more speculative and subject to price volatility. Occasionally, firms will not have their bonds rated, in which case it is solely up to the investor to judge a firm's repayment ability. Because the ratings systems differ for each agency and change from time to time, it is prudent to research the rating definition for the bond issue you are considering. (To learn more, read The Debt Ratings Debate.) 4. Bond Yields Bond yields are all measures of return. Yield to maturity is the measurement most often used, but it is important to understand several other yield measurements that are used in certain situations. Yield to Maturity (YTM) As said above, yield to maturity (YTM) is the most commonly cited yield measurement. It measures what the return on a bond is if it is held to maturity and all coupons are reinvested at the YTM rate. Because it is unlikely that coupons will be reinvested at the same rate, an investor's actual return will differ slightly. Calculating YTM by hand is a lengthy procedure, so it is best to use Excel's RATE or YIELDMAT (Excel 2007 only) functions for this computation. A simple function is also available on a financial calculator. (Keep reading on this subject in Microsoft Excel Features For The Financially Literate.) Current Yield Current yield can be used to compare the interest income provided by a bond to the dividend income provided by a stock. This is calculated by dividing the bond's annual coupon amount by the bond's current price. Keep in mind that this yield incorporates only the income portion of return, ignoring possible capital

gains or losses. As such, this yield is most useful for investors concerned with current income only. Nominal Yield The nominal yield on a bond is simply the percentage of interest to be paid on the bond periodically. It is calculated by dividing the annual coupon payment by the par value of the bond. It is important to note that the nominal yield does not estimate return accurately unless the current bond price is the same as its par value. Therefore, nominal yield is used only for calculating other measures of return. Yield to Call (YTC) A callable bond always bears some probability of being called before the maturity date. Investors will realize a slightly higher yield if the called bonds are paid off at a premium. An investor in such a bond may wish to know what yield will be realized if the bond is called at a particular call date, to determine whether the prepayment risk is worthwhile. It is easiest to calculate this yield using Excel's YIELD or IRR functions, or with a financial calculator. (For more insight, see Callable Bonds: Leading A Double Life.) Realized Yield The realized yield of a bond should be calculated if an investor plans to hold a bond only for a certain period of time, rather than to maturity. In this case, the investor will sell the bond, and this projected future bond price must be estimated for the calculation. Because future prices are hard to predict, this yield measurement is only an estimation of return. This yield calculation is best performed using Excel's YIELD or IRR functions, or by using a financial calculator. Conclusion Although the bond market appears complex, it is really driven by the same risk/return tradeoffs as the stock market. An investor need only master these few basic terms and measurements to unmask the familiar market dynamics and become a competent bond investor. Once you've gotten a hang of the lingo, the rest is easy.

What Is a Bond?
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Tips
Even risk-loving investors should consider carving out a portion of their portfolios for relatively safe bond investing.

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Consider the credit-worthiness of bond issuers. No investment is risk-free. Investors looking for the safest of safe bonds should consider Treasurys, which are issued by the U.S. government.

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Related How-Tos
What is a Mutual Fund? How to Make the Most out of Your 401(k) Plan How to Evaluate a Stock

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Send Feedback on this How-To Guide The following is adapted from The Complete Money and Investing Guidebook by Dave Kansas. Bonds are a form of debt. Bonds are loans, or IOUs, but you serve as the bank. You loan your money to a company, a city, the government and they promise to pay you back in full, with regular interest payments. A city may sell bonds to raise money to build a bridge, while the federal government issues bonds to finance its spiraling debts. Nervous investors often flock to the safety of bonds and the steady stream of income they generate when the stock market becomes too volatile. Younger investors should carve out a portion of our retirement accounts 15% or less, depending on ones age, goals and risk tolerance to balance out riskier stock-based investments. That doesnt mean that all bonds are risk-free far from it. Some bonds happen to be downright dicey. As with all investments, youre paid more for buying a riskier security. In the bond world, that risk comes in a few different forms. The first is the likelihood the bond issuer will make good on its payments. Less creditworthy issuers will pay a higher yield, or interest rate. Thats why the riskiest issuers

offer whats called high-yield or junk bonds. Those at the opposite end of the spectrum, or those with the best histories, are deemed investment-grade bonds. The safest of the safe are issued by the U.S. government, known as Treasurys; theyre backed by the full faith and credit of the U.S. and are deemed virtually risk free. As such, a Treasury bond will pay a lower yield then a bond issued by a storied company like Johnson & Johnson (investment grade). But J&J will pay less in interest than a bond issued by, say, Shady Joes Mail-Order Bride Inc. How long you hold the bond (or how long you lend your money to the bond issuer) also comes into play. Bonds with longer durations say a 10-year bond versus a oneyear bond pay higher yields. Thats because youre being paid for keeping your money tied up for a longer period of time. Interest rates, however, probably have the single largest impact on bond prices. As interest rates rise, bond prices fall. Thats because when rates climb, new bonds are issued at the higher rate, making existing bonds with lower rates less valuable. Of course, if you hold onto your bond until maturity, it doesnt matter how much the price fluctuates. Your interest rate was set when you bought it, and when the term is up, youll receive the face value (the money you initially invested) of the bond back so long as the issuer doesnt blow up. But if you need to sell your bond on the secondary market before it matures you could get less than your original investment back. Up until now, weve talked about individual bonds. Mutual funds that invest in bonds, or bond funds, are a bit different: Bond funds do not have a maturity date (like individual bonds), so the amount you invested will fluctuate as will the interest payments it throws off. Then why bother with a bond fund? You need a good hunk of money to build a diversified portfolio of individual bonds. Depending on the type of bond portfolio youre looking to build, it could require tens of thousands in order to do it right. Bond funds, meanwhile, provide instant diversification. We explain more on the differences between bonds and bond funds below. Before delving into the world of bonds, youre going to want to familiarize yourself with the types of bonds available and some of the associated vocabulary. Treasurys are issued by the U.S. government and are considered the safest bonds on the market. As such, you wont collect as much in interest as you might elsewhere, but you dont have to worry about defaults. Theyre also used as a benchmark to price all other bonds, such as those issued by companies and municipalities. Treasurys are available in $1,000 increments and are initially sold via auction, where the price of the bond and how much interest it pays out is determined. You can bid directly through TreasuryDirect.gov (with no fees) or through your bank or broker.

They also trade like any regular security on the open market. Treasury Bills, or T-bills, are a short-term investment sold in terms ranging from a few days to 26 weeks. Theyre sold at a discount to their face value ($1,000), but, when T-bills mature, you redeem the full face value. You pocket the difference between the amount you paid and the face value, which is the interest you earned. Treasury Notes are issued in terms of two, five and 10 years and in increments of $1,000. Mortgage rates are priced off of the 10-year note (more commonly called the 10-year bond even though its technically a note). Treasury Bonds are issued in terms of 30 years. They pay interest every six months until they mature. Treasury Inflation-Protected Securities (TIPS) are used to protect your portfolio against inflation. TIPS usually pay a lower interest rate than other Treasurys, but their principal and interest payments, paid every six months, adjust with inflation as measured by the Consumer Price Index. Its best to hold these in a tax-deferred account, like an individual retirement account, or IRA, because youll have to pay federal taxes on the increase in the underlying principal even though you dont get the principal back until maturity. When TIPS do mature, investors receive either the adjusted principal or the original principal, whichever is greater. TIPS are sold with five, 10, and 20-year terms. Savings Bonds are probably some of the most boring gifts out there, but it cant hurt to understand how they work. You can redeem your savings bonds after a year of holding them, up to 30 years. Theyre currently offered in two flavors, both issued by the U.S. Treasury: EE Savings Bonds earn a fixed-rate of interest (currently 3.4%) and can be redeemed after a year (though you lose 3 months interest if you hold them less than five years), but can be held for up to 30 years. When you redeem the bond, youll collect the interest accrued plus the amount you paid for the bond. They can be purchased in the form of a paper certificate at a bank for half of their face value (for example, a $100 bond can be purchased for $50) in varying increments from $50 to $10,000. If theyre purchased online, theyre purchased at face value, but can be bought for any amount starting at $25. I Savings Bonds are similar to EE savings bonds, except that theyre indexed for inflation every six months. These are always sold at face value, regardless of whether you buy paper bond certificates or you buy them electronically. Agency bonds are not quite as safe as Treasurys, but yet its often safer than the most pristine corporate bonds. Theyre issued by government-sponsored enterprises. Because these companies are chartered and regulated in part by the government, the bonds they issue are perceived to be safer than corporate bonds. They are not,

however, backed by the full faith and credit of the U.S. government like Treasurys, which would make them virtually risk-free. Municipal bonds, or Munis, as theyre commonly known, are issued by states, cities and local governments to fund various projects. Municipals arent subject to federal taxes, and if you live where the bonds are issued, they may also be exempt from state taxes. Some municipal bonds are more credit-worthy than others, though some munis are insured. If the issuer defaults, the insurance company will have to cover the tab. Corporate bonds are bonds issued by companies. Corporate debt can range from extremely safe to super risky. Coupon is another word for the interest rate paid by a bond. For instance, a $1,000 bond with a 6% coupon will pay $60 a year. The word coupon is used because some bonds really had a paper coupon attached to them, which could be redeemed for the payment. Par is also known as the face value of a bond, this is the amount a bondholder receives when the bond matures. If interest rates rise higher than the bonds rate, the bond will trade at a discount, or below par; if rates fall below the bonds rate, it will trade at a premium, or above par. Duration is a measure of a bond prices sensitivity to a change in interest rates, measured in years. Bonds with longer durations are more sensitive to interest rate changes. If youre in a bond with a duration of 10 years and rates rise 1%, youll see a 10% decline in the bonds price.
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Related WSJ Articles and Blog Posts: Smart TIPS for Bond Buyers
Should You Play The Bond Rally? How Deflation Impacts TIPS and I-Bonds

Online Tools: Key Terms -- For understanding what a bond is and what the risks are in buying that bond, from Ameriprise Financial.
Glossary -- View important definitions and click on links, from Morningstar Inc.

Additional Resources: Types of Bonds -- An overview of the different types of bonds out there, from InvestinginBonds.com.
What are Municipal Bonds -- Find out the basics of municipal bonds and how you can buy them at FMSBonds.com, a municipal bond firm. Bond Basics -- Figure out how safe your bond is, what bond ratings mean and more, from the AARP.

Should You Worry About Bond Mutual Funds if Interest Rates Rise?
April 23, 2013

Rob Williams Director of Income Planning, Schwab Center for Financial Research

Key points

Both individual bonds and bond mutual funds will drop in value if interest rates rise. Should this concern you if you're invested in bond funds? Strategies to consider to stay focused on your investment objectives and manage interest-rate risk.
"Interest rates must riseit's inevitable. And if they do, bond prices will fall." Whether you're concerned about the first part of this statement or not, the second part is unquestionably true. A rising-interest-rate climate is not good for bond investments at least in the short term. Both individual bonds and bond funds share interest-rate riskthat is, the risk of locking up an investment at a given rate, only to see rates rise. At least with an individual bond, you can re-invest it at the higher, market rate once the bond matures. But the lack of a fixed maturity date on a bond fund increases concern for many bond fund investors. Whether you're invested in bond funds for income or as part of a diversified portfolio, what should you do (if anything) if interest rates start to climb? To address this question, we'll look at the components of bond-fund returns and how different fund types might perform if rates rise. Then we'll look at a strategy to help you choose bond funds wisely based on your investment horizon.

The components of bond-fund returns

For stock mutual funds, the primary source of investor returns is rising stock prices, translated into a rising net asset value (NAV) and fund share price. Dividends can be meaningful for some fund types, but are a secondary source of return for most. Returns from bond funds, however, come from two sources: interest payments, paid out as fund dividends, and changes in price. Over time, interest payments typically contribute far more to returns than changes in price, at least for most bond funds. When bond prices increase, the rising prices increase the NAV and add to the return of a bond fund, and when bond prices fall, NAV, and returns, decline. Over time, the ups have tended to be balanced out by declines, as shown in the chart below (using the Barclays U.S. Aggregate Bond Index as a proxy for performance in a diversified, investment-grade bond fund). This has been true even over a 30-year period where interest rates have been decreasing, widely acclaimed as a 30-year bull market for bonds. Whatever happens to the value of bonds investments, however, income is always positive, and it's been the more reliable part of bond fund returns over time. More than 90% of the total return since 1976 generated from a broadly balanced portfolio of US investment-grade Treasury, agency and corporate bonds has come from interest payments as opposed to change in price, as you can see in the table below. Income drives bond fund returns over time

Source: Barclays Capital. Returns shown are from monthly Barclays US Aggregate Bond Index returns from January 1976 to December 2012. Total return equals income plus change in price with a reinvestment of interest payments. Past performance does not guarantee future results.

While price returns varied over that time period depending on interest rates and economic cycle, rising periods tended to be counteracted by periods where prices decreased. Also, unlike stocks, bonds held individually, or in mutual funds, generally mature and ultimately pay off a par value at maturity they dont rise in price indefinitely. Over time, interest payments generate the majority of returns, especially as fund managers were able to reinvest interest payments and principal to accumulate and compound over time.

Bond funds in a rising-rate environment

But what happens in the shorter term when interest rates rise? Basic bond math tells us that prices will fall if interest rates rise. The longer the maturity, the more severe the drop. However, this drop in price is not a "realized" loss unless you or the fund manager chooses to sell before maturity. Most bonds continue to generate interest payments, and their prices move back toward par at maturity, whether held by you as an individual or in a bond fund. To help gauge the interest-rate risk in your portfolio, follow these simple steps:

Find a fund's average maturityon schwab.com, enter a fund's ticker on the Mutual Funds tab under Research, then click on the Portfolio tab. You'll find the average maturity in the lower-left corner, in the Portfolio Overview section. The higher the average maturity, the more impact you'll see if rates change. Today, the average intermediate-term bond fund has an average maturity of seven years (and a duration, for more advanced investors, of 4.5.) Duration is a measure of interest rate risk. As a rule of thumb, a fund with an average duration of 4.5 will rise 4.5% in value if rates fall 1% and fall 4.5% if rates rise 1%. If they rise 2%, the drop will be roughly 9%, and so on (all else being equal). After the short-term hit of a change in price, a rising-rate environment will eventually help bond fund investors, in our view. As bonds in the fund mature, the fund manager is able to re-invest principal at higher yields as rates rise. These higher rates boost fund income returns, eventually offsetting the drop in price. The question is, "How long might this take?" If you have some sense of the answer to this question, you can focus on a question you can control: "How long is your investment horizon?" Here's a hypothetical illustration of "time to recovery," using some very basic assumptions: "Time to recovery" for a sample intermediate-term fund

Source: Schwab Center for Financial Research. Assumes starting average interest rate of 3.0%, an even 1% increase in rates each year for the first five years, average duration of 4.5 years and reinvestment of interest income. Shows cumulative return, not annualized return or dividend yield. Note: This is meant as an illustration, and wont represent actual performance for any specific mut ual fund. Actual performance will depend on fund management, as well as market conditions.

If you won't need your principal and want income during this holding period, you'll benefit from the higher yields from longer-duration (maturity) funds even if the NAV of the fund falls and recovers over time. (However, you won't benefit from the compounding of reinvested interest/dividends, as shown in the example above). Just don't forget your time horizon and risk tolerance.

Choosing bond funds by duration and your investment horizon

Professional fixed income managers, as well as pension fund and other institutional investors, often use a concept called "immunization" to match their investment horizon to interest risk, no matter the interest-rate environment. First, decide when you'll need to spend your initial investmentthat is, your principal. Might you need it tomorrow? Within the next couple of years? Four years or more, or some longer time horizon? You'll want to match your fund investments with your time horizons. For principal you might need over the next one to four years, choose short-term bond funds. Money you don't need right away, consider intermediate-term funds. Save longer-term funds only for money you won't be needing for a long time (or avoid them altogether if you'd prefer to avoid the volatility if rates rise). We see limited value and higher risks in long-term funds today compared to intermediate-term funds. The benefits of a slightly higher rate arent well-balanced with the increased interest-rate risk, in our view, for funds with average maturities much greater than 10 years. An exception might be if youre focused on income and income alone and won't need to sell, or if you believe that interest rates will fall. While we believe rates could stay lower longer than many investors expect, they will rise eventually. Match the average maturity1 of a fund with your investment horizon. Over time, this will match interest-rate risk with higher returns over this targeted investment horizon. Choose Morningstar Bond-Fund Categories Based on Time Horizon

Short-term bond funds

Intermediate-term bond funds

Long-term bond funds

Need principal in one to four years

Need principal in four to 10 years

Need principal in 10 or more years

Short government

Intermediate government

Long government

Short-term bond

Intermediate-term bond

Long-term bond

Muni national short

Muni national intermediate

Muni national bond

Source: Schwab Center for Financial Research

Keep in mind that we're not talking about when you might need to spend income, if you're an income investor, as opposed to one who doesn't need income today, but reinvests bond fund dividends to maximize total long-term returns over time. You can choose to do either. The question is principal. When might you need to sell, to cash out principal and realize any loss (or gain) from a bond fund investment? Over a longer time horizon, a fund with a similar horizon should have time to recover any drop in bond prices with higher income if interest rates do rise.

Other issues to consider

In the current low-interest-rate environment, there are a couple of other stumbling blocks to be aware of, including:

Leveraged funds. This includes many closed-end bond funds, many of which borrow money in the short-term market and then use that borrowed money to buy longer-term bonds with higher yields, adding leverage and boosting yield from the funds. This can work great when short-term interest rates are low, but it makes leveraged closed-end funds more susceptible to a more rapid decline in prices when rates rise. Unconstrained funds. Many new types of "unconstrained" or alternative strategy bond funds have been launched over the past few years. These funds use derivatives and other strategies to change duration and interest-rate risk based on market conditions. Some may even achieve a negative duration 2 through the use of derivatives. This is not a recommendation to avoid them just to understand what you own. Floating-rate funds. Many commentators have pointed to floating-rate as well as bank-loan fundsmutual funds that hold bonds whose rates adjust with market rates as a solution to manage interest-rate risk. These may make sense for some investors for a more opportunistic portion of their bond-fund allocation, but they may not provide the degree of protection in a rising-rate environment that investors may believe. Floating-rate funds are not a cure-all to interest-rate risk, and may include securities with higher credit risk or with interest-rate caps that may not increase in lock-step with the market.

Using Schwab's Fund Select List

For ideas, and the benefit of the Charles Schwab Investment Advisory Group's analysis of thousands of funds, clients can look for funds in the Morningstar fund categories referenced above on the Schwab Mutual Fund OneSource Select List. Be sure to match the type of fund with your risk tolerance and time horizon.

Next Steps
For help choosing bonds, call a Schwab Fixed Income Specialist at 877-563-7818 or visit our Bonds and Fixed Income Center.
1. More specifically, match the duration of a fund with your investment horizon. Duration measures the weighted average of the present value of the cash flows of a fixed income investment. Bonds with higher duration (given equal credit, inflation, and reinvestment risk) generally have greater price volatility than bonds with lower durations. 2. Negative duration is a situation in which the price of a bond or other debt security moves in the same direction of interest rates. That is, negative duration occurs when the bond prices go up along with interest rates and vice versa.

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Important Disclosures Investors should consider carefully information contained in the prospectus, including investment objectives, risks, charges and expenses. You can request a prospectus by calling Schwab at 800-4354000. Please read the prospectus carefully before investing. Investment value and return will fluctuate such that shares, when redeemed, may be worth more or less than original cost.
Fixed income investments are subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, corporate events, tax ramifications and other factors. For further details, please contact a Schwab fixed-income specialist. Investments in foreign assets may incur greater risks than domestic investments. Investing in emerging markets may accentuate these risks. The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data here is obtained from what are considered reliable sources; however, its accuracy, completeness or reliability cannot be guaranteed. Diversification does not eliminate the risk of investment losses. Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly. Barclays US Aggregate Bond Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage passthrough securities, and asset-backed securities. Charles Schwab Investment Advisory, Inc. is an affiliate of Charles Schwab & Co., Inc. Mutual Fund OneSource Select List is a concise list of carefully pre-screened mutual funds. The Schwab Center for Financial Research is a division of Charles Schwab & Company, Inc. Thumbs up / down votes are submitted voluntarily by readers and are not meant to suggest the future performance or suitability of any account type, product or service for any particular reader and may not be representative of the experience of other readers. When displayed, thumbs up / down vote counts represent whether people found the content helpful or not helpful and are not intended as a testimonial. Any written feedback or comments collected on this page will not be published. Charles Schwab & Co., Inc. may in its sole discretion re-set the vote count to zero, remove votes appearing to be generated by robots or scripts, or remove the modules used to collect feedback and votes.

How nominees can claim mutual fund investments

Sanket Dhanorkar, ET Bureau Aug 6, 2012, 08.40AM IST

Tags: nominees| mutual fund investments| mutual fund| investment| fund| ET Wealth| claim

We make investmetns not just to ensure our own financial well-being but also that of our loved ones. However, if we are not prudent enough to clearly earmark our assets for our dependants, they may face a hard time staking claim to these after we are gone. So, to secure your legacy and avoid disputes among heirs, you should make a will and complete the nomination formalities for all investments and accounts. These include mutual fund investments, where you can nominate a single person or open joint accounts with up to three people. Here's what to do if a unitholder dies. Demise of a single holder If there is only one holder and he dies, the person who has been registered as a nominee will have to provide proof to make claims on the investment. He will have to submit an attested copy of the death certificate, along with the following documents:

- Proof of identity of the nominee (ration card, passport, driving licence, etc). - Declaration and indemnity against any other claim, if the amount is Rs 1 lakh or more. - A copy of the account statement issued by the asset management company (AMC). - Bank account details of the new unit holder, along with attestation by a bank branch manager or a cancelled cheque with the account holder's name. - Know your customer (KYC) form of the claimant. Demise of a joint holder If the first holder dies, the units will be transferred to the second one, for which the following documents are to be submitted to the AMC: - A letter from the surviving unit holder intimating the death of the first holder. - A copy of the death certificate of the first holder certified by bankers/AMC. - Address, bank details and PAN of the second holder. - KYC of the claimant. In the case of demise of one of the joint holders (other than the first one), the investment will continue to remain in the name of the first unit holder. He will have the option to register any other person as a joint holder, for which he will need to submit the following documents: - A letter intimating the death of the joint holder. - A copy of the death certificate of the joint holder certified by bankers/AMC. - Name, PAN, signature of the new holder, who is to be registered. Demise of a holder without nomination If the single holder or all unit holders die and no nominee has been registered, the legal heirs will have to file an application if they want to claim the investment. This has to be accompanied with an attested copy of the death certificate along with the following documents: - Bank account details of the new first unit holder, along with attestation by a bank branch manager or a cancelled cheque with the account holder's name. - KYC of the claimants. - Indemnity bond from legal heir(s). - Individual affidavits from legal heir(s). - A document proving the relationship between the claimant and the deceased unit holder if the transmission amount is below Rs 1 lakh. - If the amount is more than Rs 1 lakh, the new unit holder will have to submit one of the following documents: - A notarised copy of the probated will. - A legal heir certificate/succession certificate/claimant's certificate issued by a competent court. - A letter of administration, in case of intestate succession.

Mutual Funds: Different Types Of Funds

Filed Under Beginning Investor Mutual Funds, Portfolio Management, Mutual Funds, Portfolio Management, Beginning Investor No matter what type of investor you are, there is bound to be a mutual fund that fits your style. According to the last count there are more than 10,000 mutual funds in North America! That means there are more mutual funds than stocks. (For more reading see Which Mutual Fund Style Index Is For You?) It's important to understand that each mutual fund has different risks and rewards. In general, the higher the potential return, the higher the risk of loss. Although some funds are less risky than others, all funds have some level of risk - it's never possible to diversify away all risk. This is a fact for all investments. Each fund has a predetermined investment objective that tailors the fund's assets, regions of investments and investment strategies. At the fundamental level, there are three varieties of mutual funds: 1) Equity funds (stocks) 2) Fixed-income funds (bonds) 3) Money market funds All mutual funds are variations of these three asset classes. For example, while equity funds that invest in fast-growing companies are known as growth funds, equity funds that invest only in companies of the same sector or region are known as specialty funds. Let's go over the many different flavors of funds. We'll start with the safest and then work through to the more risky. Money Market Funds The money market consists of short-term debt instruments, mostly Treasury bills. This is a safe place to park your money. You won't get great returns, but you won't have to worry about losing yourprincipal. A typical return is twice the amount you would earn in a regular checking/savings account and a little less than the average certificate of deposit (CD). Bond/Income Funds Income funds are named appropriately: their purpose is to provide current income on a steady basis. When referring to mutual funds, the terms "fixed-income," "bond," and "income" are synonymous. These terms denote funds that invest primarily in government and corporate debt. While fund holdings may appreciate in value, the primary objective of these funds is to provide a steady cashflow to investors. As such, the audience for these funds consists of conservative investors and retirees. (Learn more inIncome Funds 101.) Bond funds are likely to pay higher returns than certificates of deposit and money market investments, but bond funds aren't without risk. Because there are many

different types of bonds, bond funds can vary dramatically depending on where they invest. For example, a fund specializing in high-yield junk bonds is much more risky than a fund that invests in government securities. Furthermore, nearly all bond funds are subject to interest rate risk, which means that if rates go up the value of the fund goes down. Balanced Funds The objective of these funds is to provide a balanced mixture of safety, income and capital appreciation. The strategy of balanced funds is to invest in a combination of fixed income and equities. A typical balanced fund might have a weighting of 60% equity and 40% fixed income. The weighting might also be restricted to a specified maximum or minimum for each asset class. A similar type of fund is known as an asset allocation fund. Objectives are similar to those of a balanced fund, but these kinds of funds typically do not have to hold a specified percentage of any asset class. The portfolio manager is therefore given freedom to switch the ratio of asset classes as the economy moves through the business cycle. Equity Funds Funds that invest in stocks represent the largest category of mutual funds. Generally, the investment objective of this class of funds is long-term capital growth with some income. There are, however, many different types of equity funds because there are many different types of equities. A great way to understand the universe of equity funds is to use a style box, an example of which is below.

The idea is to classify funds based on both the size of the companies invested in and the investment style of the manager. The term value refers to a style of investing that looks for high quality companies that are out of favor with the market. These companies are characterized by low P/E andprice-to-book ratios and high dividend yields. The opposite of value is growth, which refers to companies that have had (and are expected to continue to have) strong growth in earnings, sales and cash flow. A compromise between value and growth is blend, which simply refers to companies that are neither value nor growth stocks and are classified as being somewhere in the middle. For example, a mutual fund that invests in large-cap companies that are in strong financial shape but have recently seen their share prices fall would be placed in the

upper left quadrant of the style box (large and value). The opposite of this would be a fund that invests in startup technology companies with excellent growth prospects. Such a mutual fund would reside in the bottom right quadrant (small and growth). (For further reading, check out Understanding The Mutual Fund Style Box.) Global/International Funds An international fund (or foreign fund) invests only outside your home country. Global funds invest anywhere around the world, including your home country. It's tough to classify these funds as either riskier or safer than domestic investments. They do tend to be more volatile and have unique country and/or political risks. But, on the flip side, they can, as part of a well-balanced portfolio, actually reduce risk by increasing diversification. Although the world's economies are becoming more interrelated, it is likely that another economy somewhere is outperforming the economy of your home country. Specialty Funds This classification of mutual funds is more of an all-encompassing category that consists of funds that have proved to be popular but don't necessarily belong to the categories we've described so far. This type of mutual fund forgoes broad diversification to concentrate on a certain segment of the economy. Sector funds are targeted at specific sectors of the economy such as financial, technology, health, etc. Sector funds are extremely volatile. There is a greater possibility of big gains, but you have to accept that your sector may tank. Regional funds make it easier to focus on a specific area of the world. This may mean focusing on a region (say Latin America) or an individual country (for example, only Brazil). An advantage of these funds is that they make it easier to buy stock in foreign countries, which is otherwise difficult and expensive. Just like for sector funds, you have to accept the high risk of loss, which occurs if the region goes into a bad recession. Socially-responsible funds (or ethical funds) invest only in companies that meet the criteria of certain guidelines or beliefs. Most socially responsible funds don't invest in industries such as tobacco, alcoholic beverages, weapons or nuclear power. The idea is to get a competitive performance while still maintaining a healthy conscience. Index Funds The last but certainly not the least important are index funds. This type of mutual fund replicates the performance of a broad market index such as the S&P 500 or Dow Jones Industrial Average (DJIA). An investor in an index fund figures that most managers can't beat the market. An index fund merely replicates the market return and benefits investors in the form of low fees. (For more on index funds, check out our Index Investing Tutorial.)

Next: Mutual Funds: The Costs Table of Contents 1. 2. 3. 4. 5. 6. 7. 8. Mutual Funds: Introduction Mutual Funds: What Are They? Mutual Funds: Different Types Of Funds Mutual Funds: The Costs Mutual Funds: Picking A Mutual Fund Mutual Funds: How To Read A Mutual Fund Table Mutual Funds: Evaluating Performance Mutual Funds: Conclusion

Measuring And Managing Investment Risk

August 27 2011| Filed Under Buy and Hold, Daniel Kahneman, Financial Theory, Portfolio Management, Risk Management, Trading Psychology We tend to think of "risk" in predominantly negative terms, as something to be avoided or a threat that we hope won't materialize. In the investment world, however, risk is inseparable from performance and, rather than being desirable or undesirable, is simply necessary. Understanding risk is one of the most important parts of a financial education. This article will examine ways that we measure and manage risk in making investment decisions. Tutorial: Managing Risk And Diversification Risk - Good, Bad and Necessary A common definition for investment risk is deviation from an expected outcome. We can express this in absolute terms or relative to something else like a market benchmark. That deviation can be positive or negative, and relates to the idea of "no pain, no gain" - to achieve higher returns in the long run you have to accept more short-term volatility. How much volatility depends on your risk tolerance - an expression of the capacity to assume volatility based on specific financial circumstances and the propensity to do so, taking into account your psychological comfort with uncertainty and the possibility of incurring large short-term losses. (To learn more, read Determining Risk And The Risk Pyramid and Personalizing Risk Tolerance.) Absolute Measures of Risk One of the most commonly used absolute risk metrics is standard deviation, a statistical measure of dispersion around a central tendency. For example, during a 15-year period from August 1, 1992, to July 31, 2007, the average annualized total return of the S&P 500 Stock Index was 10.7%. This number tells you what happened for the whole period, but it doesn't say what happened along the way.

The average standard deviation of the S&P 500 for that same period was 13.5%. Statistical theory tells us that in normal distributions (the familiar bell-shaped curve) any given outcome should fall within one standard deviation of the mean about 67% of the time and within two standard deviations about 95% of the time. Thus, an S&P 500 investor could expect the return at any given point during this time to be 10.7% +/- 13.5% just under 70% of the time and +/27.0% 95% of the time. (For more insight, read The Uses And Limits Of Volatility.) Risk and Psychology While that information may be helpful, it does not fully address an investor's risk concerns. The field of behavioral finance has contributed an important element to the risk equation, demonstrating asymmetry between how people view gains and losses. In the language of prospect theory, an area of behavioral finance introduced by Amos Tversky and Daniel Kahneman in 1979, investors exhibit loss aversion - they put more weight on the pain associated with a loss than the good feeling associated with a gain. (For more on this, read Behavioral Finance: Prospect Theory.) Thus, what investors really want to know is not just how much an asset deviates from its expected outcome, but how bad things look way down on the left-hand tail of the distribution curve. Value at risk (VAR)attempts to provide an answer to this question. The idea behind VAR is to quantify how bad a loss on an investment could be with a given level of confidence over a defined period of time. For example, the following statement would be an example of VAR: "With about a 95% level of confidence, the most you stand to lose on this $1,000 investment over a two-year time horizon is $200." The confidence level is a probability statement based on the statistical characteristics of the investment and the shape of its distribution curve. (To learn more, read Introduction to Value At Risk - Part 1 and Part 2.) Of course, even a measure like VAR doesn't guarantee that things won't be worse. Spectacular debacles like hedge fund Long Term Capital Management in 1998 remind us that so-called "outlier events" may occur. After all, 95% confidence allows that 5% of the time results may be much worse than what VAR calculates. In the case of LTCM, the outlier event was the Russian government's default on its outstanding sovereign debt obligations, an event that caused the hedge fund's performance to be much worse than its expected value at risk. (To learn about LTCM and other similar events, read Massive Hedge Fund Failures.) Another risk measure oriented to behavioral tendencies is drawdown, which refers to any period during which an asset's return is negative relative to a previous high mark. In measuring drawdown, we attempt to address three

things: the magnitude of each negative period (how bad), the duration of each (how long) and the frequency (how many times). FXCM -Online Currency Trading Free $50,000 Practice Account Risk: The Passive and the Active In addition to wanting to know, for example, whether a mutual fund beat the S&P 500 we also want to know how comparatively risky it was. One measure for this is beta, based on the statistical property of covariance and also called "market risk", "systematic risk", or "non-diversifiable risk". A beta greater than 1 indicates more risk than the market and vice versa. (For further reading, seeBeta: Know The Risk.) Beta helps us to understand the concepts of passive and active risk. The graph below shows a time series of returns (each data point labeled "+") for a particular portfolio R(p) versus the market return R(m). The returns are cashadjusted, so the point at which the x and y axes intersect is the cash-equivalent return. Drawing a line of best fit through the data points allows us to quantify the passive, or beta, risk and the active risk, which we refer to as alpha.

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The gradient of the line is its beta. For example, a gradient of 1.0 indicates that for every unit increase of market return, the portfolio return also increases by one unit. A manager employing a passive management strategy can attempt to increase the portfolio return by taking on more market risk (i.e. a beta greater than 1) or alternatively decrease portfolio risk (and return) by reducing the portfolio beta below 1. Influence of Other Factors If the level of market or systematic risk were the only influencing factor, then a portfolio's return would always be equal to the beta-adjusted market return. Of course, this is not the case - returns vary as a result of a number of factors unrelated to market risk. Investment managers who follow an active strategy

take on other risks to achieve excess returns over the market's performance. Active strategies include stock, sector or country selection, fundamental analysis and charting. Active managers are on the hunt for alpha - the measure of excess return. In our diagram example above, alpha is the amount of portfolio return not explained by beta, represented as the distance between the intersection of the x and y axes and the y axis intercept, which can be positive or negative. In their quest for excess returns, active managers expose investors to alpha risk - the risk that their bets will prove negative rather than positive. For example, a manager may think that the energy sector will outperform the S&P 500 and increase her portfolio's weighting in this sector. If unexpected economic developments cause energy stocks to sharply decline, the manager will likely underperform the benchmark - an example of alpha risk. A note of caution is in order when analyzing the significance of alpha and beta. There must be some evidence of a linear pattern between the portfolio returns and those of the market, or a reasonably inclusive line of best fit. If the data points are randomly dispersed, then the line of best fit will have little predictive ability and the results for alpha and beta will be statistically insignificant. A general rule is that an r-squared of 0.70 or higher (1.0 being perfect correlation) between the portfolio and the market reasonably validates the significance of alpha, beta and other relative measures. The Price of Risk There are economic consequences to the decision between passive and active risk. In general, the more active the investment strategy (the more alpha a fund manager seeks to generate) the more an investor will need to pay for exposure to that strategy. It helps to think in terms of a spectrum from a purely passive approach. For example, a buy and hold investment into a proxy for the S&P 500 - all the way to a highly active approach such as a hedge fund employing complex trading strategies involving high capital commitments and transaction costs. For a purely passive vehicle like an index fund or an exchange trade fund ETF) you might pay 15-20 basis points in annual management fees, while for a high-octane hedge fund you would need to shell out 200 basis points in annual fees plus give 20% of the profits back to the manager. In between these two extremes lie alternative approaches combining active and passive risk management. The difference in pricing between passive and active strategies (or beta risk and alpha riskrespectively) encourages many investors to try and separate these risks: i.e. to pay lower fees for the beta risk assumed and concentrate their more expensive exposures to specifically defined alpha opportunities. This is popularly known as portable alpha, the idea that the alpha component of a total

return is separate from the beta component. For example a fund manager may claim to have an active sector rotation strategy for beating the S&P 500 and show as evidence a track record of beating the index by 1.5% on an average annualized basis. To the investor, that 1.5% of excess return is the manager's value - the alpha - and the investor is willing to pay higher fees to obtain it. The rest of the total return, what the S&P 500 itself earned, arguably has nothing to do with the manager's unique ability, so why pay the same fee? Portable alpha strategies use derivatives and other tools to refine the means by which they obtain and pay for the alpha and beta components of their exposure. Conclusions Risk is inseparable from return. Every investment involves some degree of risk, which can be very close to zero in the case of a U.S. Treasury security or very high for something such as concentrated exposure to Sri Lankan equities or real estate in Argentina. Risk is quantifiable both in absolute and in relative terms. A solid understanding of risk in its different forms can help investors to better understand the opportunities, trade-offs and costs involved with different investment approaches.

The Risks of Bond Investing: Understanding Dangers in FixedIncome Investing

There's no such thing as a sure thing, even in the bond world
From Paul Conley, former About.com Guide

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Tax Free Muni Bonds Ads Get 2GB Free SamplesPrimeLoops.com/FreeSoundsDownload your Free Sample Pack Claim it Now - only at Prime Loops Invest in Fixed Depositswww.fundsindia.com/DepositsInvest in Top Corporate Deposits & Get upto 12.5% Returns. Invest Now! Supply Chain Riskwww.razient.comSupplier Risk Assessment Vendor Risk and Compliance Tracking Ads Long Term Value Fundwww.amc.ppfas.comManaging your money using Value Investing principles! Best Investment PlansPolicyBazaar.com/InvestmentsInvest Rs 8300 pm and get Rs1.35Cr in return guaranteed.Compare quotes Bonds are among the safest investments in the world. But that hardly means that theyre risk free. Heres a look at some of the dangers inherent in fixed-income investing.

Inflation Risk: Because of their relative safety, bonds tend not to offer extraordinarily high returns. That makes them particularly vulnerable when inflation rises. Imagine, for example, that you buy a Treasury bond that pays interest of 3.32%. Thats about a s safe an investment as you can find. As long as you hold the bond until maturity and the U.S. government doesnt collapse, nothing can go wrong.unless inflation climbs. If the rate of inflation rises to, say, 4 percent, your investment is not keeping up with inflation. In fact, youd be losing money because the value of the cash you invested in the bond is declining. Youll get your principal back when the bond matures, but it will be worth less.

Note: there are exceptions to this rule. For example, the Treasury Department also sells an investment vehicle called Treasury Inflation-Protected Securities.

Interest rate risk: Bond prices have an inverse relationship to interest rates. When one rises, the other falls.

If you have to sell a bond before it matures, the price you can fetch will be based on the interest rate environment at the time of the sale. In other words, if rates have risen since you locked in your return, the price of the security will fall.

All bonds fluctuate with interest rates. Calculating the vulnerability of any individual bond to a rate shift involves an enormously complex concept called duration. But average investors need to know only two things about interest rate risk. First, if you hold a security until maturity, interest rate risk is not a factor. Youll get back the entire principal upon maturity.

Second, zero-coupon investments, which make all their interest payments when the bond matures, are the most vulnerable to interest rate swings.

Default Risk: A bond is nothing more than a promise to repay the debt holder. And promises are made to be broken. Corporations go bankrupt. Cities and states default on muni bonds. Things happen...and default is the worst thing that can happen to a bondholder.

There are two things to remember about default risk. First, you dont need to weigh the risk yourself. Credit ratings agencies such as Moodys do that. In fact, bond credit ratings are nothing more than a default scale. Junk bonds, which have the highest default risk, are at the bottom of the scale. Aaa rated corporate debt, where default is seen as extremely unlikely, is at the top. Second, if youre buying U.S. government debt, your default risk is nonexistent. The debt issues sold by the Treasury Department are guaranteed by the full faith and credit of the federal government. Its inconceivable that the folks who actually print the money will default on their debt.

Downgrade Risk: Sometimes you buy a bond with a high rating, only to find that Wall Street later sours on the issue. Thats downgrade risk. If the credit rating agencies such as Standard & Poors and Moodys lower the ir ratings on a bond, the price of those bonds will fall. That can hurt an investor who has to sell a bond before maturity. And downgrade risk is complicated by the next item on the list, liquidity risk.

Liquidity risk: The market for bonds is considerable thinner than for stock. The simple truth is that when a bond is sold on the secondary market, theres not always a buyer. Liquidity risk describes the danger that when you need to sell a bond, you wont be able to.

Liquidity risk is nonexistent for government debt. And shares in a bond fund can always be sold.

But if you hold any other type of debt, you may find it difficult to sell.

Reinvestment Risk: Many corporate bonds are callable. What that means is that the bond issuer reserves the right to call the bond before maturity and pay off the debt. That can lead to reinvestment risk.

Issuers tend to call bonds when interest rates fall. That can be a disaster for an investor who thought he had locked in an interest rate and a level of safety.

For example, suppose you had a nice, safe Aaa-rated corporate bond that paid you 4% a year. Then rates fall to $2%. Your bond gets called. Youll get back your principal, but you wont be able to find a new, comparable bond in which to invest that principal. If rates have fallen to 2%, youre not going to get 4% with a nice, safe new Aaa -rated bond.

Rip-off Risk: Finally, in the bond market theres always the risk of getting ripped off. Unlike the stock market, where prices and transactions are transparent, most of the bond market remains a dark hole.

There are exceptions. And average investors should stick to doing business in those areas. For example, the bond fund world is pretty transparent. It only takes a tiny bit of research to determine if there is a load (sales commission) on a fund. And it only takes another few seconds to determine if that load is something youre willing to pay.

Buying government debt is a low-risk activity as long as you deal with the government itself or some other reputable institution. Even buying new issues of corporate or muni debt isnt all that bad.

But the secondary market for individual bonds is no place for smaller investors. Things are better than they once were. The TRACE (Trade Reporting and Compliance Engine) systemhas done wonders to provide individual bond investors with the information they need to make informed investing decisions. But youd be hard-pressed to find any scrupulous financial advisor who would recommend that your average investor venture in to the secondary market on his own.

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