The bond market is a conflicted place these days. Thanks to the ultra-loose monetary policy of the Federal Reserve, interest rates on short-term paper are close to zero. Indeed, the German government auctioned a tranche of six-month bills Jan. 9 at a negative yield for the first time ever. Some European investors are so afraid of the alternatives they’re willing to lend their money to Merkel at a guaranteed loss.
As we move out on the maturity spectrum, though, the picture changes. IOUs issued by the U.S. Treasury (and other governments perceived to be among the world’s safest) carry extremely low yields all the way out to the 30-year mark.
However, it’s still possible to earn decent rates on medium-grade U.S. corporate bonds. Investment-grade corporate issuers in the emerging markets are paying a smidgen more.
Finally, if you can accept higher risk of default, typical “junk” bonds are throwing off almost 8%, as are certain mortgages (those without backing from federal agencies like Fannie Mae or Freddie Mac).
Most of us want to collect more than a zero return on our money. Yet, like Will Rogers, we’re also concerned about the return of our money. To keep risk within reasonable limits, I advise you to put on your chef’s hat and whip up your own special blend of bonds.
Start with a small base of CDs or bank money-market accounts for ultimate safety of principal. In my portfolio, I’ve got a stash of Ally Bank CDs that pay 1.59% up front and give me a chance to raise my rate twice over the four-year term of the CD (if market interest rates go up). No minimum deposit.
Once you’ve established a base of can’t-lose money, extend your maturities a bit with a short-term bond fund. My favorite is Weitz Short-Intermediate Income Fund (MUTF:WEFIX), which hasn’t had a losing year since 1994. Current yield: 2.18%, initial minimum: $25,000. If the minimum is too steep for you, the fund has Investor Class shares – the Weitz Short-Intermediate Income Investor Fund (MUTF:WSHNX). The yield is slightly lower, but you can get in with only $2,500 — and WSHNX is available without a transaction fee through leading discount brokers.
Now you can venture a little further out on the maturity spectrum with intermediate-term bonds (typically due in five to eight years). In this category, you’ll earn a higher yield, but you’ll also expose yourself to greater fluctuations in your principal. My top fund picks here are:
Vanguard Intermediate-Term Investment Grade Fund (MUTF:VFICX): Like other Vanguard bond funds, VFICX features ultra-low operating expenses (only 22 cents a year per $100 invested). The fund also tilts toward better-quality issuers, which lowers your default risk. Current yield: 4.23%.
DoubleLine Total Return Bond Fund (MUTF:DLTNX): Managed by brilliant, opinionated bond wizard Jeffrey Gundlach, DLTNX invests heavily in mortgages, including those without backing from government agencies such as Fannie Mae or Freddie Mac. Gundlach’s style is aggressive, so you should earmark only a sliver of your wealth to this fund. But what a yield — 8%, based on the past 12 months’ distributions. Moreover, DLTNX has maintained a steady to slightly upward-trending share price over the past year — a sign that Gundlach has done a good job of selecting mortgages that continue to pay as scheduled.
The Finishing Flavor
Emerging-markets bonds are the final spice to stir into your mix. While many developed countries are fast losing creditworthiness, emerging markets as a whole have dramatically strengthened their finances since the late 1990s. In early January, Brazil auctioned a 10-year dollar bond issue at 3.449%, about the same as the French government is paying on euro-denominated debt!
Fortunately, the stampede for yield hasn’t yet snuffed out all the bargains in emerging-markets debt. A diversified ETF such as iShares J.P. Morgan Emerging Markets Bond Fund (NYSE:EMB), for example, still yields almost 5%. EMB focuses exclusively on government bonds.
If you’re O.K .with corporate debt, admittedly a somewhat riskier animal, TCW Emerging Markets Income Fund (MUTF:TGINX) is doling out a handsome 6.94%. I already own TGINX, and I like the risk-reward trade-off well enough to recommend it to you as well.