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All Contents © 2019The Kiplinger Washington Editors
By James K. Glassman, Contributing Columnist
| From Kiplinger's Personal Finance, March 2017
In part because of the election of Donald Trump, the yield on U.S. bonds—the percentage of your investment you get for holding them—has soared. For bond investors who seek relatively high income without taking inordinate risks, that spells opportunity.
You should be gradually filling out your long-term portfolio with more debt. Consider my eclectic mix of bond funds here, including mutual funds and exchange-traded funds that focus on investment-grade bonds, high-yielding "junk" bonds or tax-free municipal bonds.
Pick a mix of our six to match your desire for yield and tolerance for risk.
(All yields and prices are as of December 31.)
Expense ratio: 0.10%
One way to hedge against interest rate risk is to buy bonds that mature at intervals, a strategy called laddering. Say you buy five bonds, with the first maturing at the end of 2017, the second at the end of 2018 and so on. As each bond matures, you get your principal back and reinvest it in a new bond that matures five years later. That way, if rates rise, the last bond you purchase will carry a higher yield.
Some fund sponsors make laddering easier. For example, BlackRock offers exchange-traded funds with portfolios of corporate bonds that all mature in a specific year. One such fund is iShares iBonds Dec 2021 Term Corporate ETF. The fund, which yields 2.7% and costs just 0.10% annually, is a member of the Kiplinger ETF 20. Owning similar ETFs up and down a ladder of years can mitigate rate risk.
Expense ratio: 0.40%
Deciding whose bonds to buy is also tricky. U.S. government bonds are relatively straightforward, but corporate bonds carry the risk of default. The riskier the bond, the higher the rate a corporation must pay to entice you to own it. You should buy high-yielding corporate debt—known as junk bonds—only through a diversified fund, such as SPDR Bloomberg Barclays High-Yield Bond ETF.
Expense ratio: 0.23%
Another junk bond fund to consider is Vanguard High-Yield Corporate, a member of the Kiplinger 25, is one of the tamer funds in this junk category, opting largely for debt just below investment grade. But with less risk come lower returns than the SPDR ETF.
Expense ratio: 0.45%
Investment-grade bonds carry less risk but also pay less. Fidelity Corporate Bond has a portfolio with a median maturity of seven years and holds nearly all single-A- or triple-B-rated bonds. That seems to be the sweet spot in the market, without too much interest rate risk or credit risk (the chance that a bond’s issuer will default).
Expense ratio: 0.80%
Federal agency bonds, such as those issued by the Tennessee Valley Authority, are supersafe and yield a bit more than Treasuries. Fidelity Investment Grade Bond is a mutual fund that leavens its mixture of Treasuries and corporate bonds with some excellent agency debt.
Expense ratio: 0.52%
Municipal bonds, issued mainly by city and state governments and their agencies, have default risk, too, but less than with corporate IOUs. Plus, muni prices tend to decline less than Treasury prices if rates rise because higher inflation provides a better environment for states to raise tax dollars to fund the bonds. The advantage of munis is that their interest payments are generally free of federal income taxes and may be free of state and local taxes as well.
A good mutual fund choice for muni investors is T. Rowe Price Tax-Free Income, which combines high credit quality with maturities averaging in the 15-to-20-year range. Its yield of 2.3% translates to 4.0% for an investor in the top federal tax bracket.