Published October 2001

High-quality bonds bring stability to portfolio

By Eric Cumley
Columnist

When the stock market took off for much of the 1990s, everybody wanted to go along for the ride. Unfortunately, many investors became too enthused and put nearly all their investment dollars into stocks. This proved to be a costly mistake when the stock market declined in 2000 and well into 2001.

So, how could a person have best avoided this mistake? By following the time-tested rules of portfolio diversification. And one of the best ways to properly diversify is to take advantage of high-quality bonds.

In 2000, these bonds provided more than diversification — they also achieved very good returns. In fact, long-term U.S. Treasury bonds (those with maturities of 20 years or longer) returned 21.5 percent.

Other fixed-income investments also did well. Municipal bonds returned 11.68 percent, and U.S. agency bonds returned 12.18 percent.

Of course, you can’t always count on stellar returns from bonds such as these. However, their values typically won’t fluctuate nearly as much as stock prices. And that’s why high-quality bonds are so useful: They help balance your portfolio and ease some of the volatility caused by large swings in stock prices.

Before you invest in bonds, consider these suggestions:

• Look for quality. Major rating agencies such as Standard & Poor’s and Moody’s evaluate a bond’s quality by looking at the credit-worthiness of the corporation or governmental agency issuing the bond. These agencies assign ratings such as “investment grade,” “speculative,” “extremely speculative” and “default.” But there are variations even within these ratings categories. Generally speaking, the higher the quality of the bond, the less its return will fluctuate. So, if you’re particularly interested in stabilizing your investment portfolio, you’re best off seeking out very high-quality bonds — those rated AA+ or AAA by Standard & Poor’s, or Aa1 or Aaa by Moody’s.
• Look for the right “fit.” Your individual investment needs are not the same as everyone else’s. Consequently, some high-quality bonds will be more suitable for you than others. For example, if you are in one of the higher tax brackets, you may benefit more from a tax-free municipal bond than a taxable corporate bond.
• Build a “ladder.” Rising interest rates cause the market value of existing bonds to drop; conversely, falling interest rates drive market values up. To protect yourself against this volatility, you may want to create a “bond ladder.” To build a ladder, you simply invest in a combination of short-, intermediate- and long-term high-quality bonds. In the long run, a bond ladder can help stabilize your portfolio income, because the majority of your portfolio remains invested. Over time, a bond ladder also will generally provide you with more income than if you just purchased short-term bonds and certificates of deposit.

You can’t control the stock market’s ups and downs. Nobody can. But you can take steps to diminish the effects of these fluctuations on your portfolio. And high-quality bonds can definitely help.

Eric Cumley is an Investment Representative with Edward Jones Investments at 1201-C SE Everett Mall Way in Everett. He can be reached at 425-353-2322. Edward Jones is an NYSE-member investment firm with more than 7,000 locations nationwide.

Back to the top/October 2001 Main Menu