The case for bonds
Investor Daily: Solid corporate issues are offering juicy yields.
(Fortune Magazine) -- Boring is beautiful - or so it feels in this time of wild and crazy stock market swings. In this case we're talking about investment-grade corporate bonds, which are dirt-cheap right now for the same reason that stocks are: The market turmoil has pounded down their prices. The result is historic opportunities in bonds issued by blue-chip companies.
Right now investment-grade bonds maturing in ten years or longer are yielding an average 8.4%, according to Barclays, a remarkable 5.7 percentage points more than ten-year Treasuries. "Today's spreads are the highest we've seen since 1931," says economist Michael Darda of MKM Partners, a trading and research firm. Or as bond guru and PIMCO chief Bill Gross keeps saying, stocks are pricing in a recession, and bonds are priced for a depression. A depression isn't likely, so it's time to pounce.
In general, buying individual bonds isn't ideal. You'll need to go through a broker, and the commissions can be high. If you choose that route, you should buy at least four or five issues to diversify and stick with pummeled but steady performers like Verizon Wireless, Comcast, Xerox, and Altria, all of which offer yields of more than 8% on their ten-year bonds.
The best way to buy corporate bonds is through mutual funds. Since they own big baskets of bonds, you won't see your gains evaporate if a few holdings get downgraded or default, a major danger when you own individual issues.
Your choices fall into two broad categories. The first is for the cautious. It consists mostly of what amount to index funds; the securities are highly rated, and the expenses minimal, but the yields are relatively low. Here are two excellent choices: Vanguard Intermediate-Term Investment-Grade (VFICX). More than two-thirds of the holdings - including the likes of McDonald's and Medtronic - are rated A and above by S&P. Expenses are a tiny 0.2% and the 30-day yield stands at 7.5% (as of Dec 4). iShares iBoxx $ Investment Grade Corporate (LQD) tracks a fixed-income index for 100 household names. The portfolio is even more blue-chip than Vanguard's, and the yield is 7.3%.
The second category is for the more adventurous. The managers of these funds select lower-rated bonds that yield far more and even offer an extra kicker in capital gains. T. Rowe Price's Corporate Income Fund (PRPIX) concentrates on the lowest end of investment grade and favors high-yielding bank bonds - including J.P. Morgan's and Bank of America's - reckoning that government aid substantially reduces their risk. Its yield is 8.2%. For investors seeking bigger yields, there is Loomis Sayles Bond Fund (LSBRX). It focuses on beaten-down bonds in solid, noncyclical companies such as Kraft and Verizon. The current yield is a rich 11.2%.
For all the opportunities in corporate bonds, it's worth noting that both Treasury Inflation Protected Securities (TIPS) and municipal bonds are unusually good deals right now. In the case of TIPS, the principal is adjusted in line with the consumer price index, guaranteeing that you won't lose ground to inflation. The yield on ten-year TIPS issued in July is now 1.9%, or just 0.6 point lower than that of a ten-year Treasury, which doesn't offer inflation protection. You can buy TIPS through brokers like Schwab or at www.treasurydirect.gov. Fund investors have lots of attractive, low-expense choices, including Vanguard Inflation Protected Securities Fund (VIPSX) and T. Rowe Price Inflation Protected Bond (PRIPX).
Tax-free municipal bonds also offer extra wallop right now. Munis usually deliver lower yields than Treasuries, but the recent exodus to T-bills and bonds - and growing concerns about state credit ratings (hello, California) - has driven prices south and yields north. A triple-A-rated ten-year muni now yields 4.2%, compared with 2.5% for a Treasury. Add the tax savings, and the effective yield for someone in the highest federal bracket (35%) would be 6.5%. While defaults remain unlikely, we recommend eschewing individual bonds and single-state funds and going with funds that hold munis from across the country, such as Fidelity Tax-Free Bond (FTABX), which has an average annual return of 2.4% over the past five years, or Vanguard Long-Term Tax-Exempt (VWLTX) , which has an average five-year return of 1.8%. Like the TIPS and corporates, the munis are a tad drab; they're not the sort of glitzy investment you brag about at parties. But with their strong yields, that won't matter.