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Short-Term Bonds Offer Juicy Yields With Limited Risk

The 10-year Treasury yield has fallen 79 basis points since June 14 amid expectations the Fed might slow rate increases soon.
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The 10-year Treasury yield may have fallen 79 basis points since June 14, but now is still a good time to purchase bonds if you’re looking to buy, hold and grab some income.

That may sound counterintuitive, but short-term paper, five years or less, offers tasty yields with very little risk if you buy Treasuries, corporate bonds rated “A” or higher, or even certificates of deposit.

The beauty of buying short-term bonds is that there’s less time for something to go wrong that could lessen the ability of the issuer to make interest payments. You also don’t lose out for long if rates rise.

Full disclosure: I bought three-month Treasuries myself Aug. 4. They yield 2.65%, compared to 2.08% for a higher-than-average yielding money-market fund. This is part of my cash allocation.

When the T-bills mature in three months, I’ll either leave the proceeds in a money-market account or buy Treasuries again. At that point, many short-term bonds should offer rates higher than now, as the Fed will almost certainly raise interest rate further.

Treasury, Corporate Bond Yields

I’ve also been buying securities as part of my bond allocation, and you can do so too. For example, as of Aug. 4, a one-year Treasury yielded 3.1%, topping the 3.06% yield for two-year Treasuries, 3.01% for three years, 2.83% for five years and 2.69% for 10 years.

A one-year A-minus-rated Toronto Dominion bond yielded 3.39%, a three-year A-minus-rated Morgan Stanley bond yielded 3.74% and a five-year A-minus-rated Bank of America bond yielded 4.05%.

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It’s difficult to imagine any of these companies will have trouble repaying their debts during those periods, though obviously anything can happen.

If you prefer the safety of FDIC-insured CDs, an Ally Bank two-year CD, purchased through Fidelity Investments, yielded 3.35%. A three-year Ally CD yielded 3.4%, and a five-year Capital One CD yielded 3.4%.

Counterintuitive

You might wonder why you should consider a five-year CD yielding 3.4% when you can get a three-year CD for the same yield.

The reason is that if there’s a recession within the next three years, interest rates will likely go down. And that means the yield available on fixed-income instruments three years from now, when you want to re-invest your maturing principal, may be lower than the yield you can lock in now on a five-year security.

The idea is that rates may be more attractive five years from now than three years from now.

If you want to cover all your bases, you can establish a laddered portfolio of Treasuries going from three months to five years.

That way you won’t lose out, regardless of which section of the short-term yield curve offers higher interest rates. And if rates keep rising, you’ll benefit when you re-invest your maturing paper.