Bonds are usually the boring part of an investors' portfolio, providing a steady but small income while stocks hog the spotlight.
Not lately. Not since worries about subprime mortgages triggered an international financial crisis.
The crisis has spread so far that it might help cause a recession in the U.S. In response, the Federal Reserve has been busy cutting interest rates, and the Fed is expected to ease rates again when its policy-setting committee meets on Mar. 18.
While the credit markets remain in turmoil, BusinessWeek.com asked fixed-income experts: With interest rates falling and many parts of the credit markets still looking risky, where can investors safely go for some return?
Here are five pieces of advice:
1. Stay Away from Treasuries
Yes, Treasury bonds are the safest investment out there. But in a tumultuous time, Treasuries have gotten a little too popular, experts say. Treasuries have gotten expensive, and their returns are now paltry. Two-year notes offer a yield of about 1.6%. "Yields today suggest we are going to be in a recession for quite a while," says Joe Balestrino, fixed-income market strategist at Federated Investors (FII).
Unless the economic downturn is especially severe and nasty, it's unlikely that Treasuries will pay off.
2. Look at Muni Bonds, Despite the Bond Insurer Crisis
Municipal bonds have been in the news lately because of subprime-related trouble for many of the firms that insure the bonds. The worry about bond insurers has disrupted the market for munis, forcing some institutions to sell muni holdings and other investors to shrink away from the market for the typically tax-advantaged securities.
Munis "have all been painted with the brush of the municipal insurance debacle," says James King, president and chief investment officer of National Penn Investors Trust Company.
But that's unfair. Backed by the taxing authority of cities, states, and other governmental bodies, municipal bonds are considered almost as safe as federal Treasuries. Ironically, those municipalities are far more financially secure than the companies insuring their bonds.
Because the threat of default by municipalities is so small, the insurance troubles affect only a small part of the muni market—those riskier bonds issued by smaller bodies like hospitals or housing projects.
The muni market can be a great place to get supersafe returns at historically low prices, experts say. Plus, munis offer tax advantages for most investors, a trend that could become more important if taxes go up. "On a well-rated muni, you're getting a fantastic yield right now," says Micah Porter, a financial planner and president of Atlanta-based Minerva Planning Group.
3. Inflation Is Hard to Beat
Treasury Inflation-Protected Securities, or TIPS, are federal treasuries specially designed to resist inflation. Like regular treasuries, TIPS have gotten very popular as investors see prices rising quickly, especially on food and energy. The headline consumer price index rose 4.3% in the past year, cutting deeply into investors' real (inflation-adjusted) returns on their investments.
However, all the worry about inflation means that TIPS now trade at levels that fixed-income experts find unreasonable. "Investors are so concerned about inflation that they're trading TIPS down to paltry returns," Porter says.