The Best Bonds To Consider During Volatile Times

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BERLIN – The ups and downs that have rocked the markets recently – and seem destined to continue at least a while longer — have rattled many investors. The situation hasn’t been helped over the past few months by concerns about the unstable subprime mortgage business. Many have reacted swiftly by swapping their higher-risk stocks for safer, fixed-income investments. Wall Street expects the equity markets to remain volatile for quite some time as the credit crunch tightens and consumer spending flags.

Uncertain times like these are good cause for investors to reappraise their fixed-income portfolio, which can provide balance, safety and performance when equity markets fluctuate so rapidly. According to Merrill Lynch Fixed-Income Strategist Martin Mauro, higher-quality bonds will provide a safe haven for cautious investors for some time to come.

“This is not a time to take on more risk in the bond markets,” says Mauro. “Investors should embrace high-quality securities. … Top-rated municipal bonds, investment-grade foreign debt and certificates of deposit not only offer shelter, they also offer favorable rates of return.”

This past summer, as the markets began to react to the subprime mortgage fallout, many institutional investors started to swap lower-quality bonds of all kinds in favor of Treasuries, the safest asset available — and these bonds have appreciated.

According to Mauro, there are ways, in addition to Treasuries, for careful investors to seek other low-risk debt instruments. Among his favorites: tax-free AA- or AAA-rated municipal bonds. Besides safety, they offer attractive yields.

One overlooked source of opportunities, Mauro adds, are bank certificates of deposit. In seeking new depositors, banks have been keeping CDs at competitive levels of return for several months now. For example, recent yields on two-year CDs have been around 4.7 percent — an attractive yield, especially as money market rates could decline if the Fed cuts rates again.

To free up more of the cash you lock into CDs, Mauro suggests building a CD ladder with maturities of one year, two years, three years and so on. That way, a CD can mature every year or so, giving the investor cash to spend or reinvest. Mauro suggests replacing some money market assets with a three-year CD ladder.

In addition to considering interest-rate shifts, Mauro sees a great advantage to looking at the bond market outside our borders with a small portion of your bond portfolio.

“It’s a smart way of making the most of a potential further weakening in the U.S. dollar,” says Mauro. He cites short-term foreign investment-grade bonds as a sound way to diversify a fixed-income portfolio. In buying bonds that are backed by relatively strong foreign currencies, you can leverage a potentially weak dollar to your potential advantage. Naturally, you would lose principal value if the foreign currency depreciated against the dollar, so this strategy is not appropriate for investors who cannot accept that risk.

Simply put, the right bonds add balance to a well-diversified portfolio. And adding higher-quality bonds in volatile markets does more to protect your wealth while still providing for solid returns.

(The writer is a Merrill Lynch Senior Financial Advisor. She can be reached at 410-213-9084.)

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