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Has the time come to sell those bonds?

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By St. Louis Post-dispatch
Sunday, Jan. 6, 2013, 9:03 p.m.
 

Scott Colbert is a smart bond guy. His Commerce Bond mutual fund has beaten its index for one-, three-, five- and 10-year periods.

But these days, he's down on his bread and butter.

“I just sold my bond fund in my 401(k),” he told hundreds of the Commerce Bank customers at an economic forecast breakfast in Clayton, Mo.

Colbert likes the fund he manages, of course. It's the bond market he worries about.

Yields on domestic taxable bonds are now so pitifully low, he says, that there are better options for income-lovers willing to crawl out a little further on the limb of risk.

The iShares Core Total U.S. Bond fund, which tracks all American investment grade bonds, yields 2.4 percent — just a hair above inflation. A comparable intermediate Treasury fund would yield about 1.6 percent and a corporate bond fund 3.7 percent.

Among Colbert's favored alternatives are dividend stocks, certain preferred stocks, emerging market bonds and floating-rate bank loan funds. Lots of common stocks have dividend yields higher than bonds these days, he notes.

Those things, of course, are riskier than bonds, notes Eric Kelley, director of fixed income investment at UMB Bank. Boring government and investment-grade bonds serve as a parachute to ease your descent when the bottom falls out of riskier markets. So you should never dump them completely. Kelley worries that conservative bond investors who stray too far may be shocked at the wild drops other investments can bring.

You don't have to decide tomorrow. Rising interest rates and inflation are the main enemies of bond investors in a recovering economy. Those monsters seem likely to remain caged for the next several months at least.

So, bond investors can probably count on collecting their measly interest income with little short-term worry. But, absent a big economic shock, they'll see little of the price gains that propelled the bond market for the past three years.

Scaredy-cat investors in high tax brackets should consider municipal bonds, Colbert and Kelley say. Muni yields haven't fallen as far as corporate and government bonds, and they still offer decent value. Intermediate-term muni funds yield around 3 percent.

But watch the headlines. Muni interest isn't subject to federal income taxes, a big advantage. It's possible that rich folks might lose part of that break during the “fiscal cliff” negotiations. That could trim muni prices.

Colbert, director of fixed income investing at Commerce, thinks stocks offer better value today and will for years to come. The S&P 500 Index of big-company stocks yields a 2.2 percent dividend — nearly as much as the broad bond market — and stocks are a much better bet for price appreciation. General Electric's 3.6 percent stock dividend equals the yield on its 10-year bond.

Colbert likes some preferred stocks, such as Bank of America perpetual preferred series L (symbol BAC-pl), yielding 6.4 percent. Preferred stock pays a high dividend but has no voting rights, and the dividend can be suspended if the company gets in trouble.

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