Time Is Right to Invest in Short, Intermediate Bonds
It’s a great time for savers, with short-term interest rates at or above their highest levels in years. One of the best ways to take advantage of this is through mutual funds that invest in short- and intermediate-term bonds.
Thanks to their relative convenience, safety and potential for higher returns than money market mutual funds and bank savings accounts, these funds have grown in number and popularity in recent years. Conservative investors also like them because they are less volatile than funds investing in long-term bonds.
These funds generally invest in fixed-income securities, such as U.S. Treasury issues or corporate bonds, with maturities of less than 10 years. Many are currently yielding 9% or more, topping the averages of 8.63% on money market mutual funds, 8.51% on one-year certificates of deposit and 6.24% on bank money market deposit accounts.
If interest rates rise, however, the total return you will earn--yield plus or minus changes in bond values--can be eroded. That’s because the prices of already-issued bonds fall when interest rates rise. That happened last year, when rising interest rates pushed average total returns on short-to-intermediate bond funds down to 6.51%, compared to 7% for money market mutual funds, according to Lipper Analytical Services, a Summit, N.J., firm that tracks fund performance.
But such risks are well worth taking, particularly now that short-term interest rates have run up so high already. Yields on two-year Treasury notes, for example, have hit 9.2%. That tops 9% yields on 30-year Treasuries--which normally yield more than short-term issues.
If interest rates stay at these levels or fall, total returns may be higher. And there is virtually no chance that returns can actually be negative if interest rates rise further.
“The risk-reward relationship is very good,” says Donald J. Phillips, editor of Mutual Fund Values, a Chicago-based advisory service.
The funds also offer advantages over investing directly in Treasuries issues. Treasury bills, with maturities of between three months and one year, require $10,000 minimum investments and are often a hassle to buy and sell before maturity. Treasury notes, with maturities of one to 10 years, require minimum $5,000 investments for maturities of four years or less. Likewise, buying and selling them can be a hassle.
But funds usually require lower minimum investments and are relatively easy to buy and sell. And many fund families offer the ability for you to switch your money into other stock or bond funds in that family. That switching feature could come in handy, because if interest rates start falling, you might want to switch into longer-term funds to lock in high yields and take advantage of price rises in long-term bonds.
How should you go about picking the right fund?
Several factors are important to consider. Of course, you need to examine current yields and long-term performance--information available over the phone, in quarterly or annual reports, or through various investment advisory services.
Just as important are sales charges and expenses. Look for funds with no sales charges, or “loads,” and with low annual expenses, such as those offered by Vanguard Group. High loads and expenses can wipe out much of your return.
“It gets hard to justify paying loads for short-term funds when money market funds are available with no loads,” analyst Phillips says.
Also, funds with higher asset levels tend to enjoy lower expense ratios, says Sheldon Jacobs, editor and publisher of No-Load Fund Investor, a Hastings-on-Hudson, N.Y., newsletter.
Also, you may want to pick a fund in a group such as Fidelity, Vanguard or T. Rowe Price that has many other stock and bond funds that you can switch into if conditions merit.
What funds do experts pick?
Phillips of Mutual Fund Values likes three short-term funds: Vanguard Fixed Income--Short-Term Bond Fund (800-662-7447), with a current 30-day yield of 9.14%; T. Rowe Price Short-Term Bond Fund (800-638-5660), with a current 30-day yield of 8.51%, and Neuberger & Berman Limited Maturity (800-367-0770), with a current 30-day yield of 8.67%.
Among intermediate-term funds, Phillips favors Fidelity Intermediate-Term Bond Fund (800-544-6666), with a current 30-day yield of 8.72%, and Babson Bond Trust (800-422-2766), with a current 30-day yield of 9.2%.
Phillips also recommends Strong Income (800-368-3863), a fund that can switch from short-term bonds into longer-term issues when it thinks conditions warrant such a move. The fund also invests in higher-yielding “junk bonds” and high-dividend stocks. Its current 30-day yield is 10.52%.
If you’re in a high tax bracket, consider short- or intermediate-term municipal bond funds, which are exempt from federal taxes and possibly state and local taxes as well.
Among intermediate-term muni funds, newsletter editor Jacobs recommends Fidelity Limited-Term Muni (800-544-6666), with a current 30-day yield of 6.33%, and Vanguard Muni--Intermediate Term (800-662-7447), with a current 7-day yield of 6.97%.
Bill Sing welcomes readers’ comments and suggestions for columns but regrets that he cannot respond individually to letters. Write to Bill Sing, Personal Finance, Los Angeles Times, Times Mirror Square, Los Angeles, Calif. 90053.
