Treasury Bonds
James Shelton, chief investment officer at Kanaly Trust Co. in Houston, says this isn't a good time to buy Treasuries, and think twice before buying corporate bonds. Keep in mind that when bonds become popular, the price you pay for a bond rises and the yield drops. When bonds are unpopular, the price is low and the yield is high as bond issuers try to entice investors to buy.

"Treasuries are very expensive today. The time to have purchased them would have been in the middle of 2007. We don't believe the Treasury market offers very good value at this point," says Shelton.

"With inflation around 4 percent, you're getting a negative real rate of return. The only way I think it makes sense to buy a 3.5 percent 10-year Treasury bond today is if you think the yield is going to 3 percent, because then you'll gain from the price appreciation. But the economic outlook is going to have to get much worse for that bond to give you that kind of price appreciation."

10-year Treasury bond

Corporate bonds and municipal bonds
Corporate bonds can give you a better return than Treasuries because of the risk that the corporation may default on its obligation even if the bond has a good credit rating. But Shelton says that a slowing economic environment makes buying corporate bonds too dicey unless you're talking about bonds from the bluest of the blue chips.

"Where I do think there is very good value is in the municipal bond market. If you look across the municipal bond yield curve, you're getting rates that are comparable to Treasuries but you don't have to pay taxes on the yields. So, if you have a five-year Treasury at 2.88 percent today versus a Triple-A-rated five-year municipal bond at 2.85 percent that you're not paying tax on, that's attractive."

Historically, tax-free municipal bonds yield approximately 80 percent of their Treasury counterparts. But the spread has narrowed significantly the past year. As of this writing, the five-year Treasury is yielding 2.77 percent while the average five-year municipal's yield is 2.69 percent; approximately 97 percent of the Treasury.

Do the math
Here's how to determine if a tax-free municipal bond will give you a better return than a Treasury of equal maturity. We'll use the above numbers for this example and we'll assume a marginal tax rate of 28 percent.

After tax return = Rate of return (on the taxable bond) x (1-marginal rate)

1.99 percent is the after-tax return on a Treasury that's yielding 2.77 percent when the marginal tax rate is 28 percent. Clearly, the municipal bond yielding 2.69 percent is the better investment.

Inflation-protected bonds
Inflation-protected securities should do better in inflationary times, but investors have driven up the price of some inflation-oriented securities and that's made them a bit pricey.

An exchange-traded fund that seeks to shadow the inflation-protected sector of the U.S. Treasury market is the iShares Lehman TIPS bond, symbol TIP. Year-to-date, as of this writing, it has returned 3.96 percent. For the last quarter of 2007, it returned 11.44 percent. However, if you're late to the party, don't buy it now. The per-share price is $108.79 and financial advisers we've spoken with say it's too expensive to buy; a share price of $100 is more reasonable.

Definitions

• Yield curve -- A graph that shows the relationship between yields and maturity dates at a given point in time. • ETF -- Exchange-traded funds hold a basket of securities like mutual funds and trade like a stock. See the Guide's Glossary for a further explanation of these terms.

Another Treasury product is the I-bond, a savings bond with a variable-rate component that's meant to offset inflation. The current annual interest rate is 4.28 percent. That may seem pretty decent but, unfortunately, the bond's fixed rate component, which stays with the bond for its 30-year life, is a mere 1.2 percent. The rest of the total yield is the variable component which is adjusted semi-annually according to the government's inflation numbers.

"If inflation is running hot, the inflation-protected securities will do better than the non-protected securities, but I think the U.S. government underreports inflation, so you may give up a little bit because of that," says Marotta.