Monday, May 25, 2015

Should You Still Keep Your Bond Funds If Bond Prices Drop?

Hype about bond investors losing their shirts when long-term bond fund prices drop because of the Fed Janet Yellen's whimsies may be just that: Hype. If the share prices in a mutual bond fund go down, the dividend yields go up. If the price goes down dramatically, the dividend yield also increases, even if not in quite so dramatic a fashion.

Bonds are for Investors who are Interested in Investing

Bonds and bond funds are not for investors who view investing as another way to gamble. Unlike investors in stocks and stock funds, people who own bonds do not cherish them simply because the prices my go up. Investors own bond funds because they receive dividends every month, and they can do whatever they wish with the extra shares or money.

Reinvest Dividends or Keep the Cash

People who invest in mutual funds may not realize that they have options as to what to do with their monthly dividends. Typically, investors can reinvest the dividends back into the same bond funds, they can redirect the dividends to invest in other mutual funds or they can make arrangements to have the dividends automatically exchanged into cash via their money market accounts.

How to Handle Taxes on Dividends

Bond fund dividends held in a traditional IRA or Roth IRA are not taxable income as long as the dividends stay in the IRA account. Dividends received in a non-retirement account are fully taxable. One financial strategy is to reinvest IRA bond dividends back into the same IRA bond fund and automatically exchange non-retirement account bond dividends into cash within a non-retirement account money market fund.

In this manner, the dividends continue to grow tax-free within the investor's IRA, while the investor gains extra cash every month in the non-retirement money market fund. If a person has substantial investments, the investor will have additional money to invest in the following year's traditional IRA or Roth IRA without having to spend any extra cash for Individual Retirement Account contributions.
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