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10 Things You Need to Know About Investing in Bonds

Pros say your portfolio should have some

7. Are municipal bonds ­ — commonly called "munis" — especially risky?

Though defaults in municipals are quite rare, some professionals fear a rise in muni defaults because of the serious budget problems that many cities across the country are facing. Sullivan disagrees. "There was similar ruckus about the high-yield [junk] bond market in 2007-2008. We saw great opportunity in high-yield debt at that time, and our clients have been rewarded with wonderful returns in 2009-10."

8. Are bonds in a price "bubble"?

Some industry experts argue that bond prices have run up so high in the last two years that they're overinflated and that the current decline in prices will keep right on going. "This fear, along with headline-making predictions that dozens of state and city governments will default in 2011, has driven many investors away from bonds," says Ruff. "These concerns shouldn't prevent investors from considering the cushion that bonds can offer as part of a well-diversified investment portfolio."

9. How are bonds rated?

A bond's rating is a function of the issuer's financial strength. Rating agencies such as Standard & Poor's look at such fundamentals as sources of revenue and capitalization of the balance sheet. Bonds are rated on a scale that ranges from AAA (the best) down to D (in default). Generally speaking, the lower the rating of a bond, the higher an interest rate it pays. "Bonds rated Baa are at the low end of investment grade and, all other things being equal, should pay a higher interest rate than bonds rated AAA," says Sullivan.

10. How much of my portfolio should be invested in bonds?

The professionals give different answers, based on variables such as age of the investor and tolerance of risk. One common base is 60 percent stocks and 40 percent bonds and cash.

"Investing in bonds may not be as exciting as madly fluctuating stocks and funds," says Sullivan. But bonds can "limit risk, offer stability and are an essential part of a balanced portfolio."

For more information, see the Investing in Bonds website, operated by the Securities Industry and Financial Markets Association.

William J. Lynott is an author and freelance writer who specializes in business and financial issues.

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