2006 has been a really difficult year for investing. Everything has been so up and down, its hard to know where to put your money. (For instance, since this article on bonds went to print, the Dow rose to an all-time-high of close to 12,000 - hardly a recession.)
This article from September has some advice on bond investing, specifically on building a "bond ladder".
Should You Play The Bond Rally?
With Economic Outlook Uncertain, Experts Advise Investors to Consider Buying Shorter-Term Issues
September 27, 2006
The recent bond market rally has left many investors wondering how best to get a piece of the action now. The answer, experts say, is to diversify among a range of relatively short-term investments.
That approach, they say, allows investors to hedge against various scenarios -- important at a time when views on the economic outlook are sharply divided. Part of Wall Street is betting that recession is in the cards, which will drive yields lower. (Bond yields move inversely to bond prices, so when investors bid up prices, yields fall.) Others think inflation is the next major economic issue. That would push yields higher as investors dump bonds. (Inflation eats into bond returns.) For investors planning their income needs for the next three to five years, or investors seeking to maintain a diversified portfolio of stocks and bonds, the dueling scenarios create little more than confusion.
Experts say the solution is to diversify your bond-market bets over an array of short- and medium-term maturity dates -- a technique called laddering. This strategy allows you to pick up a decent yield while being largely protected from the bond market's swings. And they recommend the shorter term because currently, it's paying better than long-term holdings. Yesterday, the benchmark 10-year Treasury note had a yield of 4.59%, compared with an average yield of nearly 5% on money-market mutual funds.
By buying bonds with maturities of up to five years, you get "all the yield and a lot less of the risk," says Steve Bohlin, who manages several bond funds for Thornburg Investment Management.
The dilemma is a turnaround from the recent past, as 10-year Treasurys were above 5% for much of the spring and summer. This prompted many investors to lock in longer-term yields. Now, those yields have slumped again as investors have bid up prices, putting them at roughly the same level of about a year ago.
Experts caution investors to be wary of bonds stretching out past five years. The relatively low yield does not adequately compensate you "for the inflation risk you're taking," says Mr. Bohlin, the bond fund manager.
What makes the current environment so quirky for investors is that short-term rates are substantially meatier than long-term rates -- what's known as an inverted yield curve. Typically, investors are paid more to take on the added risks inherent in a longer-term investment. But today, 10-year Treasurys are at 4.59%, the two-year note is at 4.7% and the three-month bill is nearly 4.9%. And the rate on overnight bank loans, set by the Federal Reserve, is at 5.25%.
For income investors, that's making the yield on money-market accounts, CDs and even a lowly savings account seem rich by comparison.
YIELD PLAY
Experts recommend that investors diversify their fixed-income investments to hedge against bond-market volatility.
- Buy an array of shorter-term bonds and CDs to maximize yield and minimize risk, a technique called "laddering."
- Search online for the best rates on CDs, money-market and savings accounts.
- Focus on short-term bond mutual funds with low fees.
- Consider municipal bonds if you're in a high tax bracket.
