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Conclusion

Most investors can improve their balance between risk and return by placing 25% of their portfolio in different bond investments, both investment-grade and high yield. As with stocks, you can do well for yourself by selecting the right bond investments even if you choose not to adjust your portfolio once you set it up. The investments discussed in this chapter are excellent candidates for a buy-and-hold bond program.

As an example, Table 7.5 suggests a specific portfolio suitable for investors who do not want to tinker with their holdings once they get their bond investments set up. If your tax situation does not warrant holding municipal bonds, you can replace the tax-exempt bond funds in Table 7.5 with taxable alternatives: Vanguard Short-Term Investment Grade instead of Vanguard Short-Term Tax Exempt, and one of the bond funds recommended in Table 8.5 such as Pimco Total Return (class A or Institutional) instead of the Nuveen High Yield Municipal Bond Fund.

Table 7.5. Sample Buy-and-Hold Portfolio of Recommended Bond Investments

Bond Investment

Percentage of Buy-and-Hold Portfolio

Potential Risk Level

Comments

Floating rate funds (see Table 7.2)

20%

Moderate

Most have a short history, so the long-term risk is hard to project. The floating rate funds in Table 7.2 lost roughly 5% in June–August 2007.

Nuveen High Yield Municipal Bond Fund A (NHMAX)

20%

Moderate

Municipal bonds have been relatively safe in recent years, but from 1978–1981, municipal bond funds suffered losses of over 20%. Buy this fund only if you can do so without paying a sales load.

iShares Lehman Aggregate Bond Index ETF (AGG)

20%

Low-Moderate

This fund contains a mix of Treasury debt, federal Agency debt, and corporate bonds.

Vanguard Short-Term Tax Exempt (VWSTX)

20%

Low

This bond fund has not had a losing year since its inception in 1977.

Individual 10-year TIPS

20%

Low

If you hold a single TIPS to maturity, you will have no inflation risk and no default risk.

Investors who are willing to follow their bond investments can utilize the investment-grade bond ETFs (AGG or CIU) discussed in Chapter 8 for up to half of their bond investments, and can utilize floating rate funds and high yield bond funds for an equal amount. Even a bond investor willing to utilize the active strategy of Chapter 8 might want to place some capital into TIPS or munis for a really high degree of safety.

Unlike floating rate funds, high yield bond funds have for the most part been too risky to warrant holding them through thick and thin. However, high yield bonds usually pay more interest than even floating rate bank loan funds. (Market conditions in early 2007, when floating rate and high yield funds paid roughly the same, are exceptions to the rule.) Although no future results can be guaranteed, it has been possible to earn more than you would have from floating rate or investment-grade bond funds by utilizing high yield funds if you were able to avoid the periodic, major declines that have occasionally befallen the high yield market. In the next chapter, we will show you how.

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