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Short-Term Bond Funds Are Safe

But most of these funds don't pay much more than 1%.

I have money in short-term bond funds, and I’m worried about a hit from inflation. But if I keep the funds long enough, won’t the value improve as new money from maturing bonds is invested at higher rates? --W.K., via e-mail

If interest rates were to rise, you would probably lose some of your principal. But depending on the timing of cash flowing into and out of a fund, current yields would start to improve. So you would be looking at a small, one-time loss at worst.

See Also: Our Slide Show of the 10 Best Ways to Earn More Interest on Your Savings

The good news is that the principal in short-term funds is safe from interest-rate increases for now. And Kiplinger is forecasting a 2.3% increase in consumer prices this year, so we don’t think inflation will be a serious problem. More to the point, the Federal Reserve says it plans to keep short-term interest rates near zero until the unemployment rate drops substantially, and that probably won’t occur for at least two more years. The problem is that most of these funds are stuck with investments that don’t pay much more than 1%. Still, as substitutes for CDs or savings accounts, there’s nothing to worry about.

My thanks to Jeff Kosnett for his help this month.

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