The Wealthy Should Likely Park Their Money in Municipal Bonds

Bond index funds are probably not the best investment vehicles for wealthy individual investors. In general, tax-exempt municipal bonds are probably best for those whose combined federal and state tax bracket is over 28%. Although there are various actively managed funds specializing in municipal bonds, and Lehman Brothers has a municipal bond index, there is no municipal bond index fund because of complications concerning various call features and "duration options" of these bonds, among other reasons. Tax laws concerning munis vary from state to state so it might be a good idea to plug one's information into one of the following the investment planner websites: finance.yahoo.com or morningstar.com to learn more about investing in muni bonds.

Bonds May Not Diversify As Well

It may be that bond index funds and fixed income investments in general have lost some of their diversifying capabilities in recent years. In his book Stocks for the Long Run, Jeremy Siegel argues that the once negative correlation between stocks and bonds is now much more positive. Also, the presence of high yield (junk bond) debt in some full spectrum bond index funds make these funds correlate more closely with stocks, especially, perhaps, when stocks are at such high valuations.

Inflation-adjusted Bonds Work Well in Inflationary Times

In times of inflation, Inflation-adjusted Bonds offer protection against inflation while bond index funds do not. With I Bonds, as the Consumer Price Index rises, principal remains the same but interest rates increase. Conversely, bond index funds would decrease in net asset value (NAV), but yield would eventually increase. This scenario favors I Bonds.

New Products in the Bond Index Fund Arena

On June 6, 2000, Barclay's Global Investors announced that they were planning to launch the first exchange-tradable index funds focusing on the bond market. If all goes according to plan, shares will begin trading in the spring of 2001. Ten days later, on June 16, Barclays actually began trading eleven exchange-traded equity index funds that are each centered on ten different industrial sectors, such as Chemicals, and Healthcare, and one catch-all equity offering, their Total Market Index.

Some analysts find it "questionable whether bond index funds are easy enough to price and trade throughout the day for a firm to use them for an exchange-traded product." (Wall Street Journal 6/6/00) About exchange-traded bond index funds, there is also the concern that proportionately fewer traders trade bond funds short-term, and thus there might well be less demand for such an exchange-traded fund.

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