(excerpts; bold mine; other ideas in article)
STEP IT UP --- While you're making over your fixed-income portfolio, consider agency bonds, suggests Cargile. Agency bonds are issued by government agencies and government-sponsored entities such as Sallie Mae and Freddie Mac. Like Treasury bonds, they are backed by the U.S. government, but carry slightly more risk (there's nothing stopping the government from modifying its guarantee of agency debt), and so offer a higher yield. Keep in mind that agency bonds typically require a minimum investment of $10,000 to $25,000.
An Alternative Strategy: buying so-called step-up agency bonds, which are both callable -- that is, the issuing agency can redeem notes at face value prior to maturity -- and offer a fixed interest rate for a period of time. Further, if the issuing agency doesn't call the bond, it will adjust, or step-up, to a new interest rate each year until it reaches maturity. Step-up agency bonds provide a hedge against rising rates, says Cargile. "If interest rates stay low, that bond fund will perform well; if interest rates move up, the step coupon helps us in an interest-rate-rising environment
." Note that the interest from most agency bonds is exempt from state and local taxes. However, some GSEs including Freddie Mac and Fannie Mae are fully taxable.
LET IT FLOAT --- Another option is floating-rate bonds -- securitized bank loans to companies with debts that rate at or below investment-grade. These debt instruments, which are issued by banks rather than companies, receive greater priority in a bankruptcy proceeding than corporate debt issues. That means if a company defaults, floating-rate bondholders will be paid out before regular bondholders. Currently, floating-rate bond funds yield roughly 6% to 7% and their rates reset every 30 to 90 days, says Charles L. Failla, a financial planner at Sovereign Financial Group in New York. "As rates go up, they reset every day. These instruments are prime beneficiaries during a rising interest rate environment
," he says. Of course, the price for floating-rate bonds could suffer if the economy sags further and corporations start defaulting on bond issues. Essentially, if a company can't pay its debts, investors could be left holding the bag.