What we choose to fear changes as the market changes. Many people feared equities after the 2008 crash. Now the media hypes us to fear the "bond bubble".
If you have a bond fund with a five year duration, yes it will lose 5% of the NAV if interest rates rise 1%. But the current Federal funds rate is .25%. The government has been forcing the rate to this unrealistically low rate for a long time now to stimulate the economy. The fed knows that as rates rise, it will have a significant impact on the economy. That is why the bond tapering they began earlier this year is being done so gradually.
So now we fear that we may lose 10% in NAV if rates rise 2%. But for rates to rise from .25% to 2.25%, we would be talking about a rate increase of 400% (I may not have done that math on the increase right, but I know it's close).
Why would the government taper bonds so gradually, and then shock the economy by incurring a 400% increase in the lending rates? And should we really be more concerned about this happening than a major correction in a very frothy equities market?
I think it makes sense to take some precautions, but getting completely out of bonds, especially short or intermediate term, is a bit too aggressive for me. Municipal bonds offer a very attractive tax equivalent yield today. The Vanguard Long Term Tax Exempt pays a tax free yield of 3.10% and only has a 7 year duration. If you are in the 32% tax bracket, that's an equivalent yield of 4.56%. The best CD rate today is 2.25%, or less than half. When PenFed offered 3%, it was a bit more enticing. But with the spread we are seeing today between municipal bonds and the best CD rates, I don't think it makes sense to be completely out of bond funds.