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Ultrashort-term bond risk

By Judy Martel · Bankrate.com
Tuesday, October 15, 2013
Posted: 9 am ET

It's no secret to investors seeking yield that fixed income won't get you much these days. Since it's anyone's guess when the Federal Reserve will lay off its quantitative easing, many investors are taking a closer look at bonds with short durations in order to lessen the risk of loss of principle.

Know the risks and rewards of ultra-short-term bonds before investing.

Know the risks and rewards of ultrashort-term bonds before investing.

Mutual fund companies have responded to investor demand by offering ultrashort-term bond funds, designed to hold bonds with a maturity of one year or less. But while you might get a slight bump in yield when compared with a savings or money market account, these funds are investments and as such, they do carry risk.

To gain the extra yield, ultrashort-term bond funds could include risky debt, such as high-yield credit, along with the safer U.S. Treasuries or investment-grade corporate debt, according to Matthew Valeri, portfolio manager with EFG Capital Advisors in Miami, Fla.

How much risk for a little yield?

With money market funds and bank accounts earning little to no interest these days and actually losing value due to the effects of inflation, "it's tempting to go out a little further on the yield curve," says Valeri. But he cautions that investors should consider whether the small amount of extra interest earned in an ultrashort-term bond fund is worth the risk.

That's not to say that bonds and other fixed-income investments shouldn't be part of your portfolio. "Fixed income will always play a role in some investors' portfolios," says Valeri. "There's no way around it."

So, for example, if you're a retiree seeking income, you may want to include a laddered bond portfolio, which includes bonds with varying maturity dates, to mitigate interest-rate risk. Valeri suggests mixing in bonds with durations of five to seven years, three to five years, one to three years and perhaps a few ultrashort-term bonds.

Cash substitutes should also be part of an income-producing portfolio. Select those that offer the FDIC guarantee, Valeri says, which could include money market accounts, CDs and old-fashioned savings accounts. You won't get much yield, he adds, but you'll be able to sleep at night.

Read more about ultrashort-term bonds to learn about their risks and rewards.

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