A Not Too Risky Way To Double Those 3% Yields

At a time when uncertain ty rules the financial markets even more than usual, finding a good parking spot for money is no mean feat. For investors willing to move up a few notches on the risk scale, an alternative to certificates of deposit and money-market funds is short-term bond funds, which can yield close to 7%. The trade-off: You could lose principal, and if a recovery takes hold, rising short-term interest rates will nibble away at returns.

Despite the hazards, a number of investment advisers say that such funds can make good financial sense. "Money-market rates are so low that it's probably worth stepping up a little bit on the risk scale to get a return double what you'd get in a money-market fund," says Kurt Brouwer, president of Brouwer & Janachowski, a San Francisco-based investment advisory firm.

Short-term bond funds limit their interest-rate risk by maintaining the average maturity of their portfolios at just three years or less. The type of debt securities held in these funds varies greatly, with some focusing on Treasuries, others in the debt of federal agencies--such as mortgage-backed securities--and still other funds buying only corporate debt. The quality of credit also varies among short-term bond funds. Some boost yields by investing in riskier securities, including collateralized mortgage obligations, foreign bonds, and lower-rated or unrated debt.

STAYING AHEAD. What sort of damage could an increase in short-term interest rates wreak on the bond funds' returns? Thomas Poor, portfolio manager of the $2.5 billion Scudder Short-Term Bond Fund, says the interest-rate risk of his fund is 2% in capital for every 1% that interest rates rise on three-year Treasuries. With his bond fund yielding 7.25%, vs. the average money fund's 3.5%, "I have a 3.75% yield advantage over money funds, so if I lose 2% in capital, I more than make up for it in income," says Poor.

If short-term interest rates rise, as earlier this year, investors have to be prepared for fluctuations in net asset value, the price of one share of the fund's stock. After starting the year with a net asset value of $12.24, Poor's fund slipped to $11.97 by the end of March. As of June 19, it had edged back up to $12.

One way to maximize a fund's return: Check the prospectus to see that the fund has a low expense ratio and doesn't have a sales charge, or "load." If expenses are much over half a percent, the fund will be hard-pressed to make up for that in performance, says Brouwer. And in today's uncertain market, every little bit counts.

                                30-day      Total return
      Fund*                     yield       1 year
      SHORT DURATION PLUS       5.37%       10.00%
      PIMIT LOW DURATION        6.41        11.00
      SHORT-TERM CORPORATE      6.23        10.45
      LIMITED MATURITY          5.39         9.31
      * Funds buy investment-grade debt and have expense ratios under 0.70%
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