Short-Term Bond Funds Flatline
Yields are looking up, but the Federal Reserve's steady stream of rate hikes has hurt prices and kept a cap on returns
(MONEY Magazine) – What's New?
Yields on short-term bond funds are up this year--the average has risen from 2.44% to 3.22% as of Sept. 30--but the funds are expected to return just 1.5%. The problem? Seven Fed rate hikes in 2005, with another likely in December, and bond prices (and fund values) drop as rates rise.
• Stay invested. As bonds in the portfolio mature and the fund reinvests at higher interest rates next year, returns will improve.
• Go tax-free. Consider short-term muni funds. If you're in the 28% tax bracket, you earn a taxable-equivalent yield of 3.51% today (to figure that, divide the yield by one minus your tax rate).
• Get short. Funds that own bonds that mature in a year or less (known as ultrashort funds) pay as much as the average short-term bond fund today but should hold up better as rates rise.
With fewer rate hikes expected in 2006, bond prices should steady, helping short-term funds return between 3.5% and 4% for the year.
SAVINGS NOTES AND SOURCES: CD and money-market account data as of Oct. 18 from 100 Highest Yields ($124 for 52 issues; 800-327-7717). Average tax-exempt and taxable money-market fund yields for the week ended Oct. 18 from Money Fund Report (imoneynet.com); all have a minimum investment of $10,000 or less and assets of $25 million or more. Average bond fund yields for the month ended Sept. 30 from Lipper; all are medium- and high-quality funds without sales loads and with average maturities of three years or less.  Manager absorbed all or some operating expenses. CREDIT NOTES AND SOURCES: All rates subject to change. Credit-card rates are for standard cards as of Oct. 18 from Bankrate.com and are variable unless otherwise indicated. Survey does not include Internet-only cards or AmEx Blue.  Visa only.  Fixed rate.  MasterCard only.  Platinum and gold cards.