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A basic principle of investing is not to sell your stocks or equity funds when the markets are falling.

Investors seem reluctant to extend this logic to bonds. With bond yields rising, the price of bonds and bond funds has fallen on a year-to-date basis. Some people aren’t taking it well.

“A big part of my registered retirement income fund is in ZAG [the BMO Aggregate Bond Index ETF],” a retired reader recently noted. “The fund lost around 5 per cent of its value this year. Should I be alarmed? Should I sell?”

Say this reader did sell – where would the money go? Into a Canadian stock market, as measured by the S&P/TSX Composite Index, that has risen 59 per cent from its low a year ago? Into a U.S. stock market, as measured by the S&P 500, that has risen almost 72 per cent?

Maybe some dividend-paying utility stocks, stable and with high yields compared with bonds? Returns for the year to date suggest these stocks are like bonds in being sensitive to rising rates.

Or, perhaps cash. You can get as much as 1.5 per cent in a high-rate savings account at an alternative bank, but cash-like products for investment accounts pay no more than 0.25 to 0.65 per cent these days.

The case for holding onto bonds goes well beyond the lack of appealing alternatives. When stocks fall, bonds provide some buoyancy to a portfolio. The S&P/TSX Composite fell 21 per cent in the first quarter of 2020, but a balanced portfolio with a 60-40 mix of stocks and bonds might easily have lost only half that amount.

Bonds very likely have more downside as interest rates rise from their pandemic lows. But if you sell bonds now, you could easily end up in an asset class with its own set of problems. Instead of selling bonds, consider some adjustments.

A short-term bond fund offers the safety of bonds with somewhat less downside as rates rise. Corporate bonds should hold up better as well if the economy improves, plus they offer mildly better yields than government bonds. Keep ZAG or another broad-based bond fund as a long-term portfolio foundation, but reduce near-term vulnerability to rising rates with additional bond holdings.

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