What's so great about bonds? They aren't stocks

At a funeral one day, the minister stood up and said, "You know, I didn't know Ralph terribly well. Could someone stand up and say something nice about him?" Silence.

Finally, a guy stands up in the back of the room to offer words of consolation. "Yes?" the minister says. "His brother was worse," the mourner says.

It's an old joke, but for bond investors, it rings true: The only thing good that can be said about bond funds lately is that stock funds have been worse. If you're looking for someplace to put your money, a high-grade corporate bond fund might be the best place.

First, let's take a brief survey of the carnage this year:

•Short-term bond funds: -3.5%.

•Intermediate-term bond funds: -6.4%.

•Long-term bond funds: -12.3%.

Those are Morningstar's figures for average funds. Some funds fared far worse. The wretched Regions Morgan Keegan Select Intermediate Bond fund has plunged 83% this year. The larger yet still hapless Legg Mason Investment Grade Income Fund Prime is down 29%.

And high-yield, high-risk, junk-bond funds lived up to their reputations this year, falling an average 22.8% this year. One of the worst, Oppenheimer Champion Income B, has plunged 47% this year.

Why have bonds bombed? Bonds are high-quality, long-term loans. In a credit crisis — such as the one we're in now — people don't want to make loans, much less invest in them. Traders worry that the bond's issuer will default, leaving investors with high-quality wallpaper. So they sell any bonds with default potential and seek safety in bonds with no default risk — in other words, in Treasury bonds.

Default risk increases with time. You might be confident that a company will be around in three years, but you're probably not as certain about the company's future in 30 years. That's why long-term bonds got hit worse than short-term bonds.

But the major factor is the issuer's creditworthiness. In a credit crunch, no one wants to own the bonds of a company with dubious credit ratings. So junk bonds, which are issued by companies with shaky credit, have been hit the hardest of all.

When bond prices fall, their yields — the interest payment divided by their current prices — rise. For example, suppose you own a 10-year bond issued with a face value of $1,000 that pays $50 in interest every year. If traders push the bond's price down to $700, its yield soars to 7.1%.

Bond traders use a more sophisticated measure, called yield to maturity, to measure a bond's return. But the principle is the same: When bond prices fall, yields rise.

Yields are especially tempting now. For example, a 10-year Treasury note now yields just 3.66%. A bond maturing in 2018 issued by General Electric, one of the few companies that still have top-rated AAA credit, yielded 8.17% Thursday.

Investment-grade corporate bonds — that is, those that are not junk bonds — yield an average of 6 percentage points more than comparable Treasuries, says Aneep Maniar, bond analyst at Charles Schwab. Two years ago, investment-grade corporate bonds yielded less than 1 percentage point more than Treasuries.

If you can get a 9% yield or better on a high-quality corporate bond, you're getting a good deal. Stocks have earned, on average, about 10% a year since 1926. "You don't need to take a lot of risk now to really get paid," says Jim Peterson of the Schwab Center for Financial Research.

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