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Investments to avoid

By Sheyna Steiner · Bankrate.com
Friday, May 18, 2012
Posted: 11 am ET

There are not a lot of good options for investors looking for safer fixed-income products that offer decent yields. Several fixed-income portfolio managers I've spoken to recently have reported that they're more interested in investing in stocks these days as bonds are, in general, expensive and disappointing.

Yesterday that sentiment was echoed in a story on InvestmentNews titled "Gundlach: Steer clear of these bonds."

The story is based on a Bloomberg Television interview given by DoubleLine Capital's CEO and CIO, Jeffrey Gundlach, in which he advised investors to skip short-term investment-grade bonds at least out to three years and possibly as far as five years.

"There is absolutely no reason to own any investment-grade bonds inside of three years for sure," Gundlach, chief executive officer of Los Angeles-based DoubleLine, said in an interview on Bloomberg Television. "And maybe even five years is getting to that category because it has no yield."

Yields on corporate bonds have steadily declined since 2009. Over the past year, the effective yield for AAA U.S. corporates has dropped to 1.85 percent as of May 17, according to Bank of America Merrill Lynch.

Bank of America Merrill Lynch US corporate AAA effective yield

Bank of America Merrill Lynch US corporate AAA effective yield

Source: St. Louis Federal Reserve Bank/Bank of America Merrill Lynch.

Junk bonds, on the other hand, continue to offer fairly high effective yields, 12.35 percent as of May 17, according to the Bank of America Merrill Lynch index data.

Interest rates as set by the Federal Reserve will go up eventually; the question is when. When rates begin to rise, the value of bonds will go down, particularly long-term bonds. For investors who buy individual bonds, this isn't a problem; their investment will be worth the face value at maturity. Investors in bond funds will see some volatility.

That's one reason why many advisers have cautioned investors about going too far out in maturity if they're shopping for bonds now.

Staying on the short-term end of the yield curve in very high credit-quality bonds won't get you very far these days but going too long may be more risky than investors desire. Conversely, going down in credit quality can also be risky.

How do you balance searching for yield while mitigating risk?

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