Some 'safe' investments actually could be losers

Investors who can't make sense of today's stormy stock market might think the safety and security of bond mutual funds and money market accounts are a way to avoid losing money.

But many of them have opened their monthly statements only to discover they've had a negative rate of return in their fixed income accounts, and come to the sobering realization that when it comes to investing there's no such thing as a sure thing.

"What people need to realize is that even though their fixed income investments pay a fixed interest rate, their principal dollars will fluctuate with market conditions," said Nadav Baum, managing director of investments at Pittsburgh's BPU Investment Group.

In other words, if an investor owns a bond paying 5 percent interest until it matures, he will receive that fixed dividend for the life of the bond and get all of the principal back. But the actual value of the bond will fluctuate daily based on current interest rates and company and industry risk.

At any given time, the current value of an individual bond or a bond mutual fund may be worth more or less than its original cost due to daily price changes.

"My clients frequently think because a bond fund is liquid and they can see a price every day, it's a short-term investment, but sometimes the bonds inside that fund are very long -- up to 30 years," said Bill Glassner, a managing executive at Royal Alliance Associates in Cedar Knolls, N.J.

Some bond mutual funds are actually disguised as high-yield money market funds, which explains why a money market balance might show a monthly decline. Also, financial institutions that lost money on commercial paper or by betting on auction rate securities have passed those losses on to their customers who own money market accounts.

"With the subprime loan mess, the market for auction rate securities has dried up, and these banks have not been able to maintain the $1 share price (for money markets) and the value has declined," said Jeff Harris, president of Jeff Harris & Associates in Harrisonburg, Va.

"This is very unusual," he said. "You hardly ever see something like that occur. But, nonetheless, that's what we are dealing with."

The most recent example of fixed income bond funds that have failed miserably are the Morgan Keegan fund, which has lost 80 percent of its value in one year, and the Charles Schwab YieldPlus Fund, which has lost 30 percent of its value in six months.

"There are a whole bunch of hidden risks that investors have no idea about," said Andrew Stoltmann, a securities attorney for Stoltmann Law Offices in Chicago. "A lot of bond funds have high-risk investments in them, and those risks aren't made clear to investors."

Customers who suffer heavy losses in a bond mutual fund have two courses of action, he said.

Sometimes they can join a class action lawsuit if one pops up, although the average recovery is often small. The only other recourse is through the Financial Industry Regulatory Authority arbitration process.

"I talk to fixed income investors who have lost massive amounts of money, and very often the first words out of their mouth is, 'I didn't know I could lose money,' " Stoltmann said. "People have their guard down when it comes to bonds and bond funds."

Todd Chesterpal, a senior investment adviser at Pittsburgh's PNC Wealth Management, said that instead of buying bond funds, he usually advises clients to build a portfolio of individual bonds with laddered maturities.

"Bond funds can fit in certain situations," he said. "But typically we've found we can achieve a client's goal using individual fixed income securities, not funds.

(E-mail Tim Grant at tgrant(at)post-gazette.com)

(Distributed by Scripps Howard News Service, www.scrippsnews.com.)