Best Bets for Fixed-Income Investments

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What else can investors do about inflation? Not a lot. Options include immediate annuities adjusted for inflation, bonds with returns linked to commodity prices, or investing in stocks instead of bonds. But each of these approaches has its downside.

Some experts think the inflation threat is overblown, especially as housing prices fall and the economy slows down. "A financial crisis is a deflationary environment," says Robert Millikan, director of fixed income at BB&T Asset Management.

4. "Mortgage" Isn't Always a Dirty Word

The subprime crisis has many investors running scared from any sort of mortgage investment. But mortgage-backed debt makes up a large portion, about 40%, of the debt markets, and the vast majority of that is quite safe. If the housing crisis deepens, problems could spread. By picking and choosing carefully, however, investors can pick up debt backed by extremely high-quality mortgages at attractive yields.

For mortgage debt, and for almost all bonds, it is probably smartest to buy up bond funds rather than individual securities, says Francis Mustaro of J. & W. Seligman. Broad bond funds have the benefits of diversification, and they're also easier to buy and sell than individual securities. However, Mustaro says, you have to be careful that the fund's manager hasn't bought up riskier debt than the fund advertisements would suggest.

One problem with the mortgage market has been highly complicated securities that very few investors, including sophisticated financial institutions, seem to understand. Stick with simple, traditional mortgage debt. "Stay away from securities if you don't understand their structure," King says.

5. Corporate Debt Can Offer Good Returns—But Beware

Another way to get healthy returns, fixed-income experts say, is corporate debt. "If you're a risk taker," says Bill Larkin of Cabot Money Management, financial companies, especially banks, offer high yields. But Larkin, like most fixed income managers, is sticking with nonfinancials until the credit crisis winds down.

Even outside the financial sector, healthy companies with solid balance sheets are paying attractive yields. Larkin likes the debt of railroad companies, for example, which might benefit from the high price of gasoline. King is looking at industrial firms that have a long track record of paying debts on time and in full.

Millikan, however, warns that the beginning of an economic slowdown may be the wrong time to be investing in corporate bonds. "We know credit quality is going to deteriorate" he says. "It's too early."

The fixed-income market has had a rough time since the credit crisis began in July. That has rattled investors and forced many financial institutions to sell off even their good assets. "Everybody's been fleeing for the safety of Treasuries," says King. "And everything else has been left behind."

That means there are opportunities for long-term investors willing to take slightly more risk during the credit market's current bout of anxiety.

Steverman is a reporter for BusinessWeek's Investing channel.