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What To Do About Rising Interest Rates?

- Alan Lavine and Gail Liberman

Interest rates are rising. Since bond prices and interest rates move in opposite directions, bond prices are dropping.

How to handle the situation? Here are some options:

Invest in a money funds. Money funds own CDs, Treasury bills and commercial paper, which is corporate debt that typically matures in 90 days or less. The managers can roll maturing investments over at higher rates quickly. The funds also keep their share price at $1, so you should not lose principal.ye Create your own type of money fund. Invest in three-month federally insured CDs and keep rolling them over at higher rates.

Dollar cost average into bond funds. Invest regularly and you accumulate bond fund shares at lower prices. Interest rates go in cycles. When the economy heats up, as it is today, rates rise. But when the economy slows down, rates fall. Over the long term, the average cost of your bond funds shares should be lower than the market price when you sell. Don't need the income from you bond fund? Be sure to have your income automatically reinvested in new shares.

Ladder your investments. Invest in bonds, CDs or other notes that mature in different years. For example, you might buy bonds or CDs that mature in, say one to five years. Every year, when one investment matures, roll it over into another that matures in five years--or at the upper end of your ladder. This way, you roll money over at higher rates.

Target your investments specifically to meet your financial goals. Say you need $100,000 to add to your retirement stash in 10 years: You could buy a zero coupon U.S. Treasury bond that matures in 2014. The investment yields about 5.25 percent. Don't sell it, and you'll collect principal and accumulated interest at maturity. Today you can invest just $58,000 in a zero coupon Treasury bond and collect $100,000 when it matures in 2014. Keep the investment in a tax-deferred retirement account, and the money grows tax-free until you take distribution. Keep an eye out. As rates move higher, bond prices should drop even more, making this targeted buy-and-hold strategy an even better deal!ye Venturesome investors can hedge bonds. The Profunds group of mutual funds, for example, sells a rising rate mutual fund. This fund performs best when interest rates rise and bond price fall.


Alan Lavine and Gail Liberman are husband and wife columnist and authors of The Complete Idiot's Guide To Making Money With Mutual Funds, (Alpha Books). Al and Gail's new book is Rags to Retirement, (Alpha Books).

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