The Obama administration is estimating that the federal budget could double over the next decade and Moody’s Investor Service is warning that the U.S.’s AAA credit rating “could come under downward pressure” as a result, according to The Wall Street Journal. The increasing amount of government debt could set off a “triple whammy” of weak economic growth, higher inflation and higher tax bills, says Laurence Siegel, director of Research Foundation of the CFA Institute

President Barack Obama is considering raising taxes on the wealthy, increasing top rates to 39.6% from 35%, and pushing capital gains and dividends top rates to 20% from 15%. There are main strategies to help lower one’s tax burdens: First, start a Roth IRA or convert a traditional IRA into a Roth. Second, take advantage of low capital-gains rates and sell highly appreciated assets. Lastly, the tax-free income of municipal bonds become more attractive as taxes increase.

• PIMCO Intermediate Municipal Bond Strategy Fund (NYSEArca: MUNI)
• PowerShares Insured National Muni Bond (NYSEArca: PZA)
• iShares S&P National Municipal Bond Fund (NYSEArca: MUB)
• SPDR Lehman Municipal Bond ETF (NYSEArca: TFI)

When the U.S. dollar depreciates, the value of assets priced in foreign currencies tend to rise. Charlie Gushee, head of Western European sales at Auerbach Grayson & Co., suggests putting money into stable, dividend-paying foreign firms “that have zero or next to no dollar revenues.” Investing in emerging markets is also prudent since companies in these markets have dollar-denominated debt, which would be easier to pay if their local currency appreciated.

• WisdomTree International Large Cap Dividend (NYSEArca: DOL)
• WisdomTree International Utilities (NYSEArca: DBU)
• Vanguard Emerging Markets (NYSEArca: VWO)
• Emerging Global Shares Dow Jones Emerging Markets Energy Titans (NYSEArca: EEO)
  

If inflation rises, investors should consider switching regular bonds like Treasuries to Treasury Inflation-Protected Securities (TIPS). TIPS bond’s principal and interest payments grow with inflation. However, worried investors have been bidding up prices of TIPS, which is dampening yields. You may also think about corporate bonds, municipals and savings bonds, but the investments may have higher fees and difficult to sell if inflation abates.

• PIMCO Broad U.S. TIPS (NYSEArca: TIPZ)
• PIMCO 15+ Year U.S. TIPS (NYSEArca: LTPZ)
• PIMCO 1-5 Year U.S. TIPS (NYSEArca: STPZ)
• iShares Barclays TIPS Bond (NYSEArca: TIP)
• SPDR Barclays Capital TIPS (NYSEArca: IPE)

Commodities usually go up when basic materials become pricier during inflationary times. Commodity ETFs would give investors an opportunity to invest in the basic building blocks of everyday life. Still, it should be noted that a stagnant economy could weigh down commodity prices.

• iShares S&P GSCI Commodity-Indexed Trust (NYSEArca: GSG)
• PowerShares DB Agricultural Fund (NYSEArca: DBA)
• Market Vectors RVE Hard Assets Producers (NYSEArca: HAP)

For more information on investing in ETFs, visit our ETF 101 category.

Max Chen contributed to this article.

The Federal Reserve opted to leave interest rates unchanged for now, so the risk is low at this point. But as the economic recovery continues along, the risk that rates will rise is a very real one and if you’re holding bonds, you need to understand the impact that this will have.

Even after a rally going in stocks, investors are still clutching firmly to bond funds, writes Eileen Ambrose for The Baltimore Sun. Most market experts expect interest rates to start going up in the second half when the economy shows more signs of recovery, and the outcome won’t be favorable for bond holders. [How to spot and avoid ETF bubbles.]

Between January and November last year, net inflows into bonds hit $349 billion, $27 billion more than in 2008, while stocks saw outflows of $4.1 billion in the first 11 months on top of the $234 billion outflow from stocks the year before. [Bond ETFs: Good times coming to an end?]

People are still investing in bonds because of reasons like retirement, dramatizing effect of 2008 on investors and the higher yields offered as compared to money market funds. John Rekenthaler, vice president of research at Morningstar, says that high-quality bond funds such as long-term U.S. Treasuries will be most vulnerable when rates go up. High-yield funds we be least affected if rates rise in an improving economy because it is believed that companies are less likely to default in a healthy economy. [It's time to look at bonds differently.]

• iShares Barclays 7-10 Year Treasury Fund (NYSEArca: IEI)
• iShares iBoxx $ High Yield Corporate Bond (NYSEArca: HYG)
• SPDR Barclays Capital High Yield Junk (NYSEArca:JNK)

Portfolios still need some bonds for stability in the long-term. Investors may want to rearrange their holdings and stick to bonds with short-term maturities. Rekenthaler also suggests investing in funds with foreign bonds because “other countries’ interest rates might not rise and sink with ours.” Investors may also consider dividend-paying stocks or municipals as alternatives.

• iShares Barclays 1-3 Year Treasury Bond (NYSEArca: SHY)
• PIMCO 1-3 Year U.S. Treasury Index Fund (NYSEArca: TUZ)
  
• SPDR Barclay International Treasury Bond Fund (NYSEArca: BWX)
• SPDR Barclays Short Term International Treasury Fund (NYSEArca: BWZ)
• iShares S&P National Municipal Bond (NYSEArca: MUB)
• PIMCO Enhanced Short Maturity Strategy Fund (NYSEArca: MINT)
• Market Vectors Short Municipal (NYSEArca: SMB)
  
• SPDR Barclays Capital Short-Term Muni Bond (NYSEArca: SHM)

It is easy to get caught inside of a bubble and then miss warning signs that are telling you to get out. This is why we have an 8% stop loss – once a fund declines 8% off the recent high or dips below its 200-day moving average, we get out. Having a strategy with a stop-loss can help put a limit on your overall losses. [ETF trend following strategy.]

For more information about ETF strategies, check out The ETF Trend Following Playbook.

For more information on trend following, visit our trend following category.

Max Chen contributed to this article.

A bond is a loan that a bond purchaser makes to a company, as stated in American Chronicle. Thomas E. Murphy, certified financial planner at TEMAA Financial, says bonds serve to reduce volatility in a portfolio while generating income – the quarterly, semi-annual or annual fixed income is generally more than dividend payments from stocks. [iShares launches muni bond funds.]

Bonds have an inverse relationship with market interest rates – the price of a bond falls as interest rates rise. Bond investors may use a strategy called “laddering” to decrease interest rate risk by buying bonds of various maturities. As a bond matures, you may reinvest in higher-yielding bonds if rates rise. [What to watch as yields rise.]

One option for diversifying your bond holdings is by buying ETFs, which give exposure to hundreds or even thousands of bonds in one single transaction. However, it’s important to approach your bond portfolio as you would your equity portfolio and to be prepared to adjust as conditions change. [Why it's time to approach bonds differently.]

The decline in inflation, which is practically at zero, and the sharp decline in market interest rates may be indicators of a reversal of fortune for the Treasury bond market, writes Paul J. Lim for CNN Money. Peng Chen, president of the investment consulting firm Ibbotson Associates, believes a bear market in Treasuries may occur if inflation rises and the Fed has to raise interest rates.

Here are three strategies for the fixed-income investor:

• Don’t want to incur loses? There is virtually no credit risk if you stick to U.S. Treasuries since the government won’t default on the loan. But rates may rise and reduce your bonds’ value in the open market.  Among your options: Reduce risk by keeping to short-term exposure, which reduces vulnerability to price swings; keep a portion of Treasuries in individual issues and ladder your securities; and/or put some money away into Treasury inflation-protected securities (TIPs). [What to watch as bond yield rises.]
• More risk-tolerant? Consider taking on sovereign debt of other countries. Foreign debt also has the added benefit of a exchange rates, especially if the U.S. dollar is weakening. An easy way to access international Treasuries is through ETFs. [Diversify with international bonds.]
• Not too risky, but not too safe? Try adding some municipal or corporate bonds into the mix. It should be noted that munis are also free from federal tax and, in some cases, state and local taxes. Corporate bonds also help reduce a portfolio’s potential exposure to losses.

For more information on bonds, visit our bond category.

• iShares Barclays Aggregate Bond Fund (NYSEArca: AGG)
• Vanguard Total Bond Market (NYSEArca: BND)
• iShares Barclays 7-10 Year Treasury Fund (NYSEArca: IEI)
• SPDR Barclays Capital High Yield Junk (NYSEArca:JNK)
• iShares iBoxx $ High Yield Corporate Bond (NYSEArca: HYG)
• SPDR Barclays Capital Short-Term Corporate Bond (NYSEArca: SCPB)
• SPDR Barclay International Treasury Bond Fund (NYSEArca: BWX)
• SPDR Barclays Short Term International Treasury Fund (NYSEArca: BWZ)
• iShares Barclays TIPs Bond ETF (NYSEArca: TIP)
• SPDR Barclays Capital TIPS (NYSEArca: IPE)
• PIMCO 1-5 Year U.S. TIPS (NYSEArca: STPZ)
• iShares S&P National Municipal Bond (NYSEArca: MUB)
• SPDR Barclays Capital Short-Term Muni Bond (NYSEArca: SHM)

Max Chen contributed to this article.

Municipal bond mutual funds increased 14.4% on average through Oct. 29 and yields have not experienced their current lows in more than four decades, reports Jonathan Burton for The Wall Street Journal. The surge in muni bonds may be over, but some believe this investment vehicle still have a place in many portfolios, especially as tax time looms. (The current bond hot spots).

Many states face deep budget deficits, potential downgrade risk and headline risk. Bonds usually drop in price when credit ratings are bad or when budget deficits are high.

Still, muni bonds appeal to investors because of of their tax-free income status. Munis are generally exempt from federal and state level taxes. Their tax-free status will become more appealing as federal income taxes become higher as the Bush administration’s tax cuts expire at the end of 2010.

Currently, the supply/demand imbalance is supporting the price of municipal bonds. Professionals suggest potential investors stick to bonds with at least a single-A rating. They also note that long-term bonds are more susceptible to interest rate changes and don’t provide enough to compensate. (What you need to know about bond ETFs).

For more information on municipal bonds, visit our municipal bond category.

• PowerShares Insured National Muni Bond (NYSEArca: PZA): up 16.3% year-to-date; yields 4.5%

• iShares S&P National Municipal Bond (NYSEArca: MUB): up 5.9% year-to-date; yields 3.6%

• SPDR Barclays Capital Municipal Bond (NYSEArca: TFI): up 8.1% year-to-date; yields 3.68%

• Market Vectors Long Municipal (NYSEArca: MLN): up 20.4% year-to-date; yields 4.49%

Max Chen contributed to this article.

According to Randall W. Forsyth of Barron’s, the rally has been specifically seen in the credit markets, in particular corporate securities as opposed to lower-risk Treasury securities.

One reason that bond ETFs are remaining attractive it because the credit markets are giving investors a better return than the near-zero return earned in money-market and cash accounts.  Additionally, with the ever-growing number of options available, bond ETFs enable investors to make both bearish and bullish plays on the market.

If the economy improves, corporate credit will benefit. If this happens, Treasury yields are apt to rise. Conversely, if the economy falls short of the bulls’ expectations, Treasury yields may fall but corporate spreads could widen and hurt corporate bond returns. Have a strategy in order to protect yourself.

The iShares iBoxx $ Investment Grade Corporate Bond (NYSEArca: LQD) is up 9.3% year-to-date and has a yield of 5.33%.

The SPDR Barclays Capital High Yield Bond Fund (NYSEArca: JNK) is up 31.3% year-to-date with a yield of 12.9%.

Even municipal bonds have seen a nice uptrend.  Take a look at the iShares S&P National Municipal BondETF (NYSEArca: MUB) which is up 8.7% year-to-date with a yield of 3.63%.  Additionally, State Street Global Advisors recently launched the SDPR Standard & Poor’s VRDO Municipal Bond ETF (NYSEArca: VRD),which is designed to provide investors with access to muni variable-rate demand obligations.

For more stories on bond ETFs, visit our bond ETF category.

Kevin Grewal contributed to this article.

For full disclosure, Tom Lydon’s clients own shares of LQD.

Assets: $1.3 billion

Holdings: The fund holds investment-grade municipal bonds, rated at least BBB- by Standard & Poor’s, Baa3 by Moody’s or BBB- by Fitch. Each bond must be denominated in U.S. dollars and have a minimum term to maturity of one calendar month.

Objective: MUB seeks to track the iShares S&P National AMT-Free Municipal Bond Index.

What’s Good

• MUB has an expense ratio of 0.25% with 409 holdings
• Yields 3.64%
• It’s up 6.1% year-to-date
• Muni bonds are exempt from federal taxes and, in some cases, state and local taxes

The Latest News

• Among fixed-income funds in the third quarter, municipal bonds nabbed seven of the top 10 spots
• There is still a large amount of debt hanging over many state and local economies, so demand for debt investments could remain high, according to analysts
• Municipal bond ETFs offer many benefits as they give investors a low-cost and safe way to invest in the municipal market
• Since municipal bonds are more transparent than any other bond, you know exactly where your money is

Go here for more ETF Spotlights.

Although there is a large debt hanging over state and local economies, the demand for debt investments should stay in high demand, according to analysts. Individual investors are scooping these investments up and the acceptance rate of these are high. Money News reports that demand was evident in the first-quarter’s big finish, with the issuance of about $12 billion in debt in the final week of the quarter, including a massive California deal, making this the best advance since December 2006.

The second largest flow into this investment area was seen in mutual funds, which posted a net inflow of $13.9 billion last quarter. The rush proved rewarding for retail investors who bought into municipal bond mutual funds, said one Lipper analyst. The quarterly performance of muni bond funds of 4%- 7% returns shows that the performance is attractive.

The authorities have pumped more than $1 trillion into the economy and lowered interest rates to nearly zero, leaving the possibility of inflation looming further down the road, but it’s not an imminent factor. This is another reason many investors have flocked to this area of the market. Investors should keep an eye out for inflation in the future, however.

Municipal bond ETFs offer many benefits as they give investors a low-cost and safe way to invest in the municipal market. And since municipal bonds are more transparent than any other bond, you know exactly where your money is.

• iShares S&P National Muni-Bond ETF (MUB): up 3.4% year-to-date; 3.6% yield

If you are searching for a bond-focused ETF to help round out your portfolio or keep assets in safety, the good news is there are about 58 different bond funds on the market. Jeffrey R. Kosnett for Kiplinger explains that this is more than enough to build any imaginable income portfolio, taxable or tax-exempt, using ETFs exclusively.

Overall, bond ETFs are pretty straightforward, easy to interpret and fill investment needs expediently. Among the ways they can be used:

• Treasury ETFs come in a range of maturities, and you can shift them up or down depending on where you think interest rates are headed. If you think they’re heading up soon, then long-term bonds would take a hit.
• With corporate bond ETFs, you can select from a few ETFs that target hunk bonds. There are also a number of ways to access investment-grade funds, as well.
• Worried about inflation? Try TIPS (Treasury inflation-protected securities). iShares Barclays TIPS Bond (TIP) and SPDR Barclays Capital TIPS (IPE) have an average maturity of nine years, and buys TIPS across the yield spectrum. The so-called Tips funds are are good preparer for inflation, which many say is looming ahead of us in the near future. Richard Lehman for Forbes says that while people are talking so much about deflation, what people should be wary of is inflation. While inflation can provide short-term relief, it’s harmful in the long run because it stifles real growth, hurts productivity and hurts savers.
• If you just can’t decide, try a total bond market ETF. The Vanguard Total Bond Market Index (BND) and iShares Barclays Aggregate Bond Fund (AGG).
• Municipal bonds are proving to be a safe haven in these current market conditions. Under “normal” market conditions, the tax-free municipal bonds usually yield less than taxable bonds. Since the market is upside down right now, the non-taxable bond can actually offer better yields than most. Since states and towns can raise taxes to meet debts, muni bond defaults are extremely rare (but still possible). iShares S&P National Municipal Bond (MUB) and SPDR Barclays Capital Short-Term Muni Bond (SHM) are two ways to access this market.

Discuss fixed-income in our forums. How do you use these ETFs in your portfolio?

A few bond funds and their charts:

• iShares Barclays Aggregate Bond Fund (AGG) down 1.9% year-to-date; current yield 4.53%

• iShares Barclays 7-10 Year Treasury Fund (IEI): down 0.61% year-to-date; current yield 2.79%

• SPDR Barclays Capital Long Credit Bond ETF (LWC): up 1.2% year-to-date

Retirees and income-oriented investors alike enjoyed gains averaging 4.6% in the six national, short and intermediate-term tax-free municipal bond ETFs on the market. Municipal bonds have been overlooked because of their slow, but sure nature.

Chance Carson for Index Universe reports that the muni-bond area is proving to be a safe haven in these current market conditions. Under “normal” market conditions, the tax-free municipal bonds usually yield less than taxable bonds. Since the market is upside-down right now, the non-taxable bond can actually offer better yields than most.

Since states and towns can raise taxes to meet debts, muni bond defaults are extremely rare (but still possible). If you’re looking for high yields and low taxes, munis look like one of the best deals out there, says John Waggoner for USA Today.

Some of the municipal bond focused ETFs on the market:

• iShares S&P National Municipal Bond (MUB): up 0.89% year-to-date, yields 3.55%

• SPDR Barclays Capital Short-Term Muni Bond (SHM): up 1.6% year-to-date; yields 2.52%

• Market Vectors Short Municipal ETF (SMB): up 3% year-to-date; yields 2.57%

The plus side is that the new muni ETFs provide a safer, lower cost way of investing in municipal bonds than either municipal bond mutual funds or direct investments. The bad news? Today’s investment climate is so crazy that market watchers warn that the muni market could be rough this year.

As an investment vehicle, muni ETFs have a lot going for them. Generally, fees are about half of a municipal bond fund-0.20% to 0.40%, compared to 0.50% to 0.80%. Right now, even if it’s just half a percent you’re saving, that’s a lot of money.

Muni ETFs are also more transparent than most bond funds, which only have to report what they held last quarter. They’re slightly more liquid, too. Unlike mutual funds, which can only be sold at the net asset value of the prior day’s closing price, muni ETFs can be sold at the prevailing price any time during the day.

There’s not been a hiccup as far as trading, the spreads have been very reasonable and manageable, reports On Wall Street.

On the plus side, yields are high right now relative to U.S. Treasuries. In ordinary times, municipals trade at yields a little lower than Treasuries, pricing in their tax advantages.

Munis are also tax-free, of course, and double-tax free if your client is a New Yorker or Californian who buys a home-state muni ETF. Defaults can happen, but are rare, at least compared to corporates. The major downside to the muni market is that since the insurance is not available, institutional investors steer clear of this investment class. Both leveraged investors and individuals are not interested in munis either.

To cope with the downside risk of a muni ETF, keep your eye on the 200-day moving average, and if the fund falls below this, it may be time to get out.

• iShares S&P National Municipal Bond ETF (MUB): up 1.2% year-to-date; up 0.4% for one week; 3.55% yield