Interest rates are so low right now that they have nowhere to go but up. But rising rates spell trouble for bond fund investors. Why? It’s like a teeter-totter.

When interest rates go up, bond fund prices go down. How far down depends on the average maturity date of the bonds in the fund. The longer its maturity, the more sensitive a bond is to interest rate changes.

How much will your bond fund decline when rates rise? There’s an easy way to calculate your potential loss.

Find out the average maturity of the bonds in your fund. You can find this information in the prospectus or with any of the fund rating services. Let’s say your fund has a duration of 8 years. If interest rates rise 1%, your principal will decline 8%. If your fund’s duration is 5 years and rates go up 1%, your principal will decline 5%. And so on.

Bond funds have done well in recent years because interest rates have declined. But individual bonds are a better place to be when rates go up. For one very simple reason: the peace of mind that comes from knowing your principal is safe.

The Beauty of Individual Bonds

Individual bonds have a maturity date. Bond funds do not. When you own an individual bond, you are guaranteed to get your original investment returned to you at maturity. There is no guarantee that you will ever get your original investment back in a bond fund.

Take a look at the following chart.

It shows the net asset value of a well known government securities fund over the last 25 years. Despite an overall declining interest rate environment, the price per share is actually down 20% from its peak. And this fund is not the exception.

What to do?

If you own a bond fund with longer maturities, wwitch into a portfolio in your fund family that has shorter maturities.

Better yet, sell your bond fund and buy individual bonds. If you want to buy government bonds, you can do so without paying any commission. You can open an account directly with the U.S. Treasury here.

Two-year Treasuries pay 0.61%. Go out 10 years, and you’ll get 2.96%. But to get far better returns on your ultra-conservative bond investments, I urge you to consider subscribing to Steve McDonald’s Bond Trader service.

Steve does all the work for you. He tells his subscribers what bonds to buy, how much to pay, and when to sell.

Steve’s Bond Trader service delivers great returns to his subscribers by following three rules:

· He buys only ultra-short maturities – bonds that mature in three years or less. This takes the threat of inflation out of the picture.

· He buys only investment-grade bonds.

He buys most of his bonds at a discount to face value.

Does it really work?

Let me give you an example:

Last year on June 2, Steve recommended a Textron bond that was to mature in 2014. The bond was paying interest at 5.125%. The going purchase price was $840, which equated to a discount of $160 ($1,000 minus $840).

Just four months later, on October 27, Steve sent an alert to his subscribers to sell the Textron bond at $940 to $950.

Let’s say you had purchased five of those Textron bonds. Your cost was $4,200. Had you sold the bonds on October 27 for $950, you would have ended up with $4,843.50. A profit of $643.50! That’s $93.50 in interest and $550 in capital gains.

Here are a couple of Steve’s other actual trades:

• Fifth-Third Bank

4.2% coupon, maturity date 2/2010, “A” rated
Recommended at 66 on 10/2/08; sold at 97 on 1/6/09
Expected return: 45% annualized
Actual return: 209% annualized

• Sallie-Mae

5.4% coupon, maturity date 10/2011
Recommended at 66 on 4/7/09; sold at 84 on 6/12/09
Expected return: 27% annualized
Actual return: 165% annualized

Steve has helped a lot of investors get off the stock market roller coaster… and enjoy the peace of mind that comes from knowing their original investment is guaranteed. For more information on Steve’s Bond Trader service, click here.