Interest rates have risen dramatically in recent months, as investors begin to anticipate that the Federal Reserve will ease off on the extraordinary measures it has taken to stimulate economic activity. Because of the way bond prices work, those rising rates have hurt the value of existing bonds, producing major losses for unsuspecting investors.
How Bad Did Bonds Do?
Bond losses have been widespread and significant. General-purpose bond funds like Vanguard Total Bond Market ETF (BND) and Pimco Total Return ETF (BOND) have given up 4 percent to 5 percent of their value since the beginning of May, while investment vehicles that focus on longer-term bonds, such as the iShares Barclays 20+ Year Treasury Bond ETF (TLT), have posted double-digit percentage drops. Even the inflation-adjusted iShares TIPS Bond (TIP) ETF -- which many turned to as a way of avoiding potential bond-market volatility -- has dropped almost 8 percent since the end of April, even as inflation remains largely under control.
Many people have moved their bond money into the stock market and other alternative investments. With high dividend yields, you can get more income from those investments than bonds pay right now. But they also come with considerable risk of loss.
With the goal of safety and security in mind, let's look at some bond alternatives that won't make you lose your shirt.
1. Bank CDs.
Certificates of deposit look almost exactly like bonds, in that you make an upfront deposit in exchange for the promise of your money back after a certain time and interest payments along the way. But unlike bonds, you usually have the right to withdraw your money from a CD early, paying only an interest penalty rather than any decline in the market value of a bond.
In fact, some banks pay slightly better yields on their CDs than comparable government bonds of the same duration, even though both are guaranteed by the full faith and credit of the U.S. Treasury. With price protection and better income, bank CDs are a no-brainer compared to Treasury bonds right now for most individual investors.
2. Savings Accounts.
Bank savings accounts carry the same federal deposit insurance that CDs do. The difference, of course, is that with savings accounts, you don't have to lock up your money for a set period of time.
Of course, the price of that flexibility is a lower rate, with many well-known banks paying almost no interest at all. But if you do your shopping and are open to using online banking, you can find savings accounts that pay as much as 1 percent -- comparable to the rates you'll find on many CDs that force you to tie up your money for a year or two. Having the money liquid will let you jump on higher-rate opportunities as they arise.
3. Savings Bonds.
Savings bonds are an easy way to put money to work safely, as they too are obligations of the U.S. government. They come in two types: series I bonds and series EE bonds.
- I-bonds have interest rates that are linked to the current rate of inflation, with new I-bonds paying 1.18 percent during their first six months. After that, the rate will change to match whatever the increase in the consumer price index was over the preceding six-month measuring period.
- EE-bonds, on the other hand, only pay 0.2 percent, making them a poor short-term alternative. But if you hold EE-bonds for 20 years, you're guaranteed to double your money -- which equates to an average 3.5 percent annual interest rate.
With bonds producing big losses for unsuspecting investors, take a look at these bond alternatives. They won't necessarily give you a huge amount of income right now, but they'll prevent the losses that you've seen in your regular bond holdings -- and could continue to see for the foreseeable future.
You can follow Motley Fool contributor Dan Caplinger on Twitter @DanCaplinger or on Google Plus.