Bonds In Your Portfolio

Go ultra-short.

The rates for 6-12 month bonds aren't very high but they're better than money market rates. Think of what you would do if stock prices were falling. You would get out of some of your stock positions and find opportunities to reinvest in stocks with better values. Right? Same here. In 6 or 12 months, you can reassess your bond positions and look for better value opportunities.

• Invest in a bond fund.

There are plenty to choose from. There are ultra-short and short-term funds, in addition to intermediate-term and long-term funds. There are high-yield funds, as well. High-yield ("junk") bonds have recently come down to earth. In fact, there's one high-yield bond fund among the top 10 performing funds of the last year, as listed in CBSMarketWatch (Pioneer Global High Yield Fund Class A Shares).

Ultra-short and short-term funds have not done well recently. Long-term funds have done better. And emerging-market funds have done very well. Four of them have made the top 10 list, along with three emerging-country debt funds (a close cousin).

• Get familiar with preferred stocks, which essentially act as bonds.

Many companies offer preferred stocks that provide dividends at favorable yields. Richard Lehmann notes in his Forbes Soapbox column that "the bond market is overvalued at all rating levels. The preferred market is undervalued from the BB-rated level and up. These securities are called 'stocks,' but they are really an array of securities that could hardly be described as equity."

• Invest in foreign bond funds.

This is a play on the dollar that assumes the dollar will continue to slide. You have to be careful. Morningstar analyst Lynn Russel says that currencies "bring a lot of volatility to the table." If you notice the dollar strengthening, sell right away, she warns. You can make the same play closer to home with U.S. mutual funds investing in foreign debt. American Century Intl Bond-Inv and FFTW International are just two of several funds that do this, according to Forbes.

• Invest in TIPS and I-Bonds.

Treasury Inflation-Protected Securities (TIPS) rise with the inflation rate. The dividend rate stays the same but, as the same percentage of a higher principal, it will also go up in absolute terms. At the end of the maturity period, you'll get the inflation-adjusted principal. I-Bonds carry a low fixed interest rate plus the inflation rate tacked onto it. You get the accumulated interest when you cash out on the bond or it matures. Both TIPS and I-Bonds are exempt from local and state taxes.

• Buy top-graded munis.

You cannot control inflation. But you can reduce your tax payments on bond returns by buying municipal bonds (munis). Like TIPS and I-Bonds, they are exempt from state and federal taxes. Rates become almost a third higher if you're in the top tax bracket.

So here's the point . . .

Bonds will never make you broke while you're sleeping. You should make them part of your overall investment portfolio for that reason alone. Ladder your bonds. Buy and hold. And choose carefully from among the thousands of investment-grade bonds available. If in doubt, munis and U.S. Treasuries are always safe bets.