A `short cut' to higher yields.

As interest rates are cut, investors can capitalize on short-term bond funds

The Federal Reserve's repeated interest-rate cuts may eventually shock the economy back to life and rejuvenate the stock market. In the meantime, though, yield-oriented investors are paying the price. "At the beginning of 2001, the average money market fund was yielding around 6%," says Peter G. Crane, vice president and managing editor at iMoneyNet Inc. in Westborough, Massachusetts. "Since then, the average yield has fallen to 3.5%, and further declines are possible."

If that 3.5% seems skimpy to you, you can find higher yields in ultra-short and short-term bond funds. Ultra-short bond funds currently have average maturities of 2.5 years, according to Morningstar Inc., the mutual fundtracking company in Chicago, and average yields of 6.6%. Short-term bond funds have average maturities of 3.5 years and average yields of 5.9%. Short-term government bond funds have average maturities of 4.2 years and average yields of 5.5%.

But how much risk are you taking with a short or ultra-short fund? One way to tell is to track a fund's performance over time. Among ultra-short funds, Scott Berry, an analyst at Morningstar, favors Strong Advantage Investor (STADX). In the past 10 years, this fund's share price has fluctuated between $9.88 and $10.19 per share, a fairly narrow band. If you can tolerate such volatility, you stand to reap a high yield: Strong Advantage was paying 6.6% recently.

One reason for such a high yield is that Strong Advantage invests in short-term corporate debt, where yields are relatively high. "You're getting high yields, but you're also taking credit risks with such a fund," says Roger Van Pelt, director of planning with Tyler Wealth Counselors of West Chester, Pennsylvania.

Van Pelt says he prefers Vanguard Short-Term Treasury (VFISX), which holds only short-term obligations of the federal government. "For true diversification away from the stock market, we recommend funds such as this one, which holds no corporate debt. Like all Vanguard funds, the expense ratio is extremely low (0.27%), and in a bond fund, a low expense ratio is a key factor in greater returns," he says. This Vanguard fund's share price fell to $9.79 in 1994, a rough year for the bond market, but since then has ranged between $10 and $10.37. Recently, the yield was 5.7%; and because the interest comes from U.S. Treasury securities, it's exempt from state and local income tax. (To find top short-term bond funds, based on one-year total returns, see chart on this page.)

Your personal situation can help you decide whether to invest in short or ultra-short funds, according to Crane. "If you think you might need cash right away, stay with a money market fund," he says. "Don't risk losing principal just to increase your current yield. However, if you don't expect to need cash for a year or more, you probably can increase your return by moving into a fund with slightly longer maturities of between two and five years."

TOP SHORT-TERM GOVERNMENT FUNDS
                                       Year-to-Date       1-Year Ann.
Fund Name  (Ticker)                   Total Return(*)     Total Return

American Cent Inf-Adj Inv (ACITX)          6.33%             13.58%
Managers Interm Dur Gov (MGIDX)            3.23              13.08
Accessor Mortgage Sec Adv (AMSFX)          3.22              12.98
Eaton Vance Govt Oblig A (EVGOX)           4.00              12.09
Asset Mgmt Interm Mort Secs (ASCPX)        3.15              11.99

                                         3-Year Ann.        5-Year Ann.
Fund Name  (Ticker)                    Total Return       Total Return

American Cent Inf-Adj Inv (ACITX)          7.33%                -
Managers Interm Dur Gov (MGIDX)            5.85               7.11
Accessor Mortgage Sec Adv (AMSFX)          6.30               7.56
Eaton Vance Govt Oblig A (EVGOX)           5.87               6.42
Asset Mgmt Interm Mort Secs (ASCPX)        6.33               7.11

                                       Toll-Free          Minimum
Fund Name  (Ticker)                      Number      Initial Investment

American Cent Inf-Adj Inv (ACITX)     800-345-2021         $2,500
Managers Interm Dur Gov  (MGIDX)      800-835-3879          2,000
Accessor Mortgage Sec Adv (AMSFX)     800-882-9612          5,000
Eaton Vance Govt Oblig A (EVGOX)      800-225-6265          1,000
Asset Mgmt Interm Mort Secs (ASCPX)   800-527-3713         10,000

(*) Return through May 31, 2001
Source: Morningstar Inc.
TOP SHORT-TERM BOND FUNDS
                                        Year-to-Date     1-Year Ann.
Fund Name (Ticker)                     Total Return(*)   Total Return

PIMCO Real Return Bond A (PRTNX)             7.32%           15.23%
PIMCO Total Return Mtg D (PTMDX)             3.87            14.21
Advantus Mortgage Secs Inc A (ADMSX)         4.08            14.14
Deutsche Short-Term Inc A (FLINX)            3.52            12.30
Harris Ins Sh/Int Bond N (HIMBX)             3.54            12.29

                                        3-Year Ann.     5-Year Ann.
Fund Name (Ticker)                     Total Return   Total Return

PIMCO Real Return Bond A (PRTNX)           9.67             -
PIMCO Total Return Mtg D (PTMDX)           7.05             -
Advantus Mortgage Secs Inc A (ADMSX)       7.11           8.11
Deutsche Short-Term Inc A (FLINX)          6.04           6.66
Harris Ins Sh/Int Bond N (HIMBX)           5.95           6.54

Fund Name (Ticker)                      Toll-Free         Minimum
                                          Number      Initial Investment
PIMCO Real Return Bond A (PRTNX)
PIMCO Total Return Mtg D (PTMDX)       888-877-4626       2,500
Advantus Mortgage Secs Inc A (ADMSX)   800-225-8570       2,500
Deutsche Short-Term Inca (FLINX)       800-665-6005         250
Harris Ins Sh/Int Bond N (HIMBX)       800-730-1313       2,000
                                       800-982-8782       1,000

Moreover, short and ultra-short funds may make ideal "parking lots" for money you eventually tend to invest. "You could park the money in a short-term bond fund and gradually move it into stocks," says Van Pelt. "In the meantime, the money in the bond fund will earn a higher yield than it would in a money market fund. Even if interest rates fall some more, dropping your yield, you stand to benefit from price appreciation because the bonds in the fund will gain value."

Just be sure to look closely at any fund before signing a deposit slip. "These funds are not homogeneous," says Morningstar's Berry. "Some hold government obligations while others hold corporate paper; some ultra-short funds keep maturities under one year while some short-term funds go out three years or longer." The lower the credit quality of the paper and the longer the maturity, the higher the yield, but also the greater the risk if a fund's manager comes up short in trying to foresee the future.