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Thursday, October 7, 2010

Finding Fixed Income Investments with Decent Returns

Since the recent financial meltdown, Federal Reserve directors have forced market interest rates to be extremely low. If you are trying to find a safe investment that pays a decent interest rate, you are mostly out of luck. Have you checked Certificate of Deposit interest rates at your local bank lately? Don't - it will make you nauseous!

If you want to stay with fixed income investments (as opposed to common stocks) and if you are willing to take a little more risk, you might search for a short term bond mutual fund. To get an idea of what you might find, go to Morningstar and follow these steps:

  • Click on "Funds" at the top of the screen
  • Scroll down and look for "Fund Screener" in the left column. Click on it.
  • You will see some criteria you can use in searching for a fund. To start with, set these criteria:
    • "Fund Group" - select "Taxable Bond"
    • "Cost and Purchase" - Select "$3,000"
    • "Load Funds" - Select "No-load funds only"
    • "Morningstar Star Rating" - Select five stars
    • "Morningstar Risk better than or equal to" - Select "Average"
    • "YTD return greater than or equal to" - Select "Category Average"
    • "1-year return greater than or equal to" - Select "Category Average"
    • "3-year return greater than or equal to" - Select "Category Average"
    • "5-year return greater than or equal to" - Select "Category Average"
    • "Average Credit Quality" - Select "A or higher"
    • "Duration" - Select "Less than 5 years"
  • Click "Show Results"
Several funds will probably be displayed in a "Snapshot" format. At the top of the chart, change the "View" to "Performance". You can review the returns these funds have generated over several time periods. If you would like to look at details regarding a particular fund, just click on its name. If you would like to modify the selection criteria you used, click on the "Change Criteria" tab. For example, you might change the "Duration" field to "Less than 3 years". When you "Show Results" again, you'll see a shorter list.

I've intentionally used shorter duration bonds in this example. As interest rates rise, bond values fall. So, in this world of very low rates, there is no where for the rates to go but up. By limiting your investment to shorter duration bonds, the effect of rising rates will not be as damaging. Once interest rates reach "normal" levels, you can consider medium and long term bonds.

Please do not invest in any of these funds based solely on what you have read in this post. To educate yourself, start by reading the advantages and disadvantages of investing in bonds here: Ohio State University FactSheet - Investing in Bonds. Talk with your financial planner if you have one. If you don't, at least seek advice from others. If you would like, feel free to ask a question on this blog by posting a comment.

Here's a link to an earlier post about Morningstar.

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