As investors learned in 2000, there are times when bonds outperform stocks. At year-end, with the S&P 500 down around 10%, the Lehman Brother Long Treasury Bond Index was up 20%.
Thus, you probably should hold a 10%-30% portfolio allocation in bonds and bond funds for true diversification. If you’re 100% in stocks, you’re probably taking too much risk for no reason.
Adding some bonds to your portfolio will reduce your exposure to steep market drops, yet a portfolio with a modest allocation to bonds is still likely to generate the returns you need to meet your goals.
According to Morningstar Inc., Chicago, most taxable bond funds now yield 5.5%-6.5% while tax-exempt municipal bond funds yield 4.5%-5%. Even higher yields are available in high-yield (junk) bonds, where the average yield is over 11%. The junk bond market has suffered through three dismal years, in 1998, 1999, and 2000, so a rebound might be in sight.
