Bonds are shining a little brighter this year
After a long, long period of ultra-low interest rates, Treasurys, corporates, and munis are offering fatter yields.
(FORTUNE Magazine) - Keep it short. That's been the best advice for fixed-income investors for quite a while. With rates stuck at record lows, it didn't make sense to lock up your money for long periods. But over the past two years, the Federal Reserve has raised short-term interest rates 16 times to keep the economy from overheating and inflation at bay. While the rate hikes have pushed down the value of existing bonds, they've also made today's yields much more attractive. The payout on a two-year Treasury note, for example, has climbed from 3.5% last year to 5% today.
So we're changing our advice from "stay short" to "go medium." While interest rates may climb a bit higher, most analysts believe that this round of hikes is nearly over, making it a good time to lock in rates for two years or more. Bill Hornbarger, A.G. Edwards's chief fixed-income strategist, says that the intermediate part of the yield curve is the place to be - for example, taxable government and corporate bonds with maturities of seven to ten years, currently yielding around 5%, and muni bonds maturing in five to seven years, yielding about 4%. "You get a pretty good yield," he says. "You've locked in your income stream for a longer period of time, and you've made yourself a little less sensitive to changes in Fed policy."
Two Vanguard funds, Intermediate-Term Bond Index fund (Charts) andIntermediate-Term Investment Grade (Charts) , are inexpensive and safe ways to get into the sweet spot of the yield curve. Both charge annual expenses of less than 0.2% and have returned better than 5% annually since 2001.
For investors in the 25% tax bracket and above, tax-free municipal bonds offer an advantage over their taxable cousins. Among muni bond funds, one of the best is Eaton Vance National Limited Maturity Municipals (Charts) , which ranks in the top 5% of its category over the past five years.
If you, like new Fed chairman Ben Bernanke, are worried about inflation, you'll want to consider the Treasury's inflation-protected securities, or TIPS. The face value of TIPS - and thus the payout - rises twice a year to keep pace with the consumer price index, making TIPS the one sure-fire way of beating inflation. The Vanguard Inflation-Protection Securities fund (Charts) has returned 7% annually over the past five years.