Investment Basics

How to invest money in 2011 depends on whether there is a bond bubble and whether or not the bubble bursts or at least deflates. First we'll explain a bond bubble and how it will affect bond funds. Then, we get down to how to invest in funds just in case the worst happens in 2011 or 2012.

It's harder for most people to understand a bond bubble than it is to understand a stock bubble like we had in the year 2000. That's because most folks don't understand the securities involved - let alone know how to invest money in them directly. Hence, people rely on bond funds that own these debt securities in their portfolio to do the management for them. Stocks and bonds are both securities that trade in the open market once they are issued to the public, and the price of both fluctuates. The same is true of the price or value of funds that invest in either of these securities. In 2011, it's time to think twice before you invest money, or if you have money invested in bond funds.

A bond bubble refers to extremely high prices in the market for longer-term debt securities called bonds, and this is a result of interest rates falling to extreme lows. Because rates have fallen for so long and have fallen so far leading up to 2011, prices have gone way up. This is because these securities pay what looks like a high interest income that is fixed and never changes. All of these securities also have a fixed date when they mature, which means the owner is paid back the principal borrowed by the bond issuer, which is usually $1000. In simple terms, you don't need to be concerned with the details if you invest money in bond funds because the fund deals with the details. You just need to know how to invest and where to invest money in these funds.

When any financial bubble deflates, prices fall. When a bubble bursts, prices fall severally. Memorize these two rules on how to invest in bond funds, just in case there is a bond bubble. First, if interest rates go up prices will fall. Second, long-term funds will get hit hardest, intermediate-terms funds will fall less, and short-term funds will be much less affected. Long-term funds pay considerably higher interest income, but in 2011 they carry much more risk.

Short-term bond funds hold issues that mature is just a few years. Hence the fund won't get stuck holding them for long if interest rates soar. On the other hand, long-term funds hold issues that mature in 20 years or so. If rates soar, they have two negative choices: sell at a loss or hold on and hope things turn around. If investors panic and cash in their funds, the fund company must start selling bonds in their portfolio to raise cash to pay folks back. As selling intensifies, prices tumble even more. That's the worst scenario: the bond bubble bursting. So, the question is how to invest your money in bond funds in 2011 without too much risk?

Invest your money in funds with AVERAGE MATURITIES in their portfolio of 7 years or less. These will be labeled as intermediate-term and short-term funds. If you have money in long-term funds, switch it over. If you have new money to invest, avoid long-term funds. If there is a bond bubble and it does deflate or burst, you can put money into longer-term bond funds later when prices are down. Until then, how to invest your money amounts to: better safe than sorry in 2011.

Author James Leitz teaches investment basics, stocks, bonds, mutual funds and how to invest in his investing guide for beginners called INVEST INFORMED. Put Jim's 40 years of investing experience to work for you and get up to speed at http://www.investinformed.com. Learn how to invest.