What Do You Do When Your Bonds Give Nothing Back? Don't 'Chase Yield'

NEW YORK (TheStreet) -- Most long-term investors own bonds or bond funds, hoping they'll provide some safety and perhaps do well when stocks don't. But bond investors have been living on faith in recent years due to low yields and the picture isn't getting brighter.

Yields on long-term bonds have continued to fall this year while short-term yields have held pretty steady. That's what experts call a "flattening of the yield curve," and it signals poor bond returns coming. Long-term bonds pay higher yields because investors tie their money up longer, taking on greater risks. When the curve gets flatter, that risk premium gets smaller.

The culprit is slow economic growth around the world. Since the end of the last recession, the U.S. economy has grown by only about 2.3% a year, compared with 3.3% in the prior 10 years. Inflation is running around 1%, half the Federal Reserve's 2% target. Low inflation sparks concerns about three possibilities, according to Morningstar, the market-data firm:

"Deflation is a sustained fall in the general price level of goods and services, while disinflation occurs when the inflation rate is positive but declining. Lowflation refers to an inflation level that's consistently lower than the rate targeted by monetary policymakers."

When prices fall, for example, consumers postpone purchases and businesses avoid investment, undermining economic growth. Falling prices are especially bad for borrowers, because their debts and payments remain the same while their incomes may get smaller.

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