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New Funds Limit the Risks of Bond Investing

Tax-free investors can try iShares 2017 S&P AMT-Free Municipal (MUAF), which yields 0.65%. That is the equivalent of a taxable bond that yields about 1.1% for high-income investors.

The iShares fund, which tracks a high-quality benchmark, has 86% of its assets in bonds that come with the top two ratings, double-A and triple-A.

You can get a higher yield with Fidelity Municipal Income 2017 (FMIFX), a mutual fund that delivers a tax-free yield of 0.96%.

The Fidelity fund yields more because it is an actively managed fund that tries to outdo its benchmark. To boost returns, the portfolio managers sometimes take bonds that are rated triple-B, the lowest rung in the investment-grade universe. The Fidelity portfolio currently has 60% of assets in securities rated double-A or triple-A.

The defined-maturity ETFs can be sound choices for retirement savers. Say you plan to retire in 20 years, and you want to hold bonds. You could buy a 20-year bond. But that is a bad bet because rates are low. If rates rise, you could be stuck holding a low-yielding security.

To spread your risk, build a ladder with defined-maturity ETFs. To do that, you buy ETFs with a maturity dates of 2013, 2014 and so on. That way you have assets maturing every year that can be reinvested. If rates rise, you can enjoy some higher yields.

Investors who hold the funds until maturity should receive fairly predictable returns. Fidelity portfolio manager Mark Sommer says that you can get a rough idea of what his annual returns will be by checking the Securities and Exchange Commission 30-day yield. A fund that yields 1.0% is likely to deliver annual returns of about that much.

But there could be some variations. The funds mature on specific days, such as July 1. Because it is impossible to find 80 bonds that all mature on the same day, the portfolio managers must include securities that mature before and after the date.

When bonds mature early, the managers hold cash until the final date. If the bonds mature after the target date, the managers must sell the securities before the maturities and distribute the proceeds to shareholders. So if you pay $25 for shares, you may not get that exact amount back on maturity. But the funds should prove fairly reliable and enable cautious investors to make careful plans.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.
Stan Luxenberg is a freelance writer specializing in mutual funds and investing. He was executive editor of Individual Investor magazine.
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