Exploding Myths About Investing in 'Safe' Bonds

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Inflation is now historically quite low, but many economists expect it to rise soon, eating away at investment returns. You don't want to be stuck in the wrong long-term Treasury – or corporate bond, for that matter -- at 2 percent when inflation jumps to 4 percent.

How should you deal with these factors? The first option is to not deal with them at all by staying away from U.S. bonds and instead buying other investments, such as stocks. Though many analysts believe we're entering another slow decade for stock returns, a diversified portfolio of relatively low-risk stocks (like blue chips) can help you preserve capital and flight inflation.

On the other hand, if, like millions of other investors, you're so intimidated by the current stock market that you want to join the herd taking refuge in U.S. bonds, there are some ways to minimize their downsides. These include:

• Keeping durations short.

The shorter the term of your bond, the less exposure you have to rising interest rates and creeping inflation. Durations of one or two years can help you sleep at night by reducing these risks.

• Considering a U.S. bond ladder.

Laddering strategies involve buying bonds with overlapping durations so that you that you take advantage of rising coupon rates while reducing inflation risk. But keep in mind that can be complicated; ladders aren't your father's U.S. bond investment. If ladders aren't executed correctly and attended to diligently, they can be a lot of trouble for little gain.

• Investing in inflation-protected issues.

The U.S. government issues two varieties: savings bonds called I-bonds (the "I" stands for inflation-indexed) and TIPs (Treasury Inflation-Protected Securities). Both of these investments pay the rate of inflation (adjusted periodically) plus a fixed rate. That way, you are guaranteed of getting the full value of the fixed rate because inflation doesn't eat into this yield.

When it comes to avoiding default, you can't beat U.S. government bonds. But this investment is hardly secure if market and economic factors end up shrinking capital that could have found a more lucrative home. In U.S. bonds, as in any investment, there's no free lunch.

This work is the opinion of the columnist and in no way reflects the opinion of ABC News.

Ted Schwartz, a Certified Financial Planner®, is president and chief investment officer of Capstone Investment Financial Group. He advises individual investors and endowments, and serves as the advisor to CIFG UMA accounts. Because Schwartz has a background in psychology and counseling, he brings insights into personal motivation when advising clients on achieving their wealth management goals. Schwartz holds a B.A. from Duke University and an M.A. from Oregon State University. He can be reached at ted@capstoneinvest.com.

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