Bonds: They're Better Than You Think

Sept. 29, 2009 — -- The pain of last year's steep stock market declines remains fresh in the minds of investors.

That's why many continue to steer clear of stocks and keep their savings parked in cash, despite the pitiful interest rates currently paid on CDs, money market funds and other cash accounts.

Some investors prefer an FDIC guarantee even if it means earning just 1.5 percent on a one-year certificate of deposit. They just can't stomach the thought of exposing themselves to the types of stock market losses they experienced last year. And that I can understand.

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But let me remind these folks that there is a middle ground that offers the potential for higher returns without taking on the risk of stocks. That middle ground is bond investing.

Bonds are a prudent way to rebuild your investing confidence after the scariest episode in our lifetimes. Start with bonds and then move up the investment ladder slowly.

What you want ultimately is a portfolio that includes a mix of both of stocks and bonds along with a dash of cash. The size of each portion will differ by investor.

Historically, bonds have outperformed cash holdings and underperformed stocks. In recent years, however, bonds as a whole have outdone stocks.

Over the past five years, the Barclays Capital U.S. Aggregate Bond Index -- a measure of the overall U.S. bond market -- offered an average total return of 5.5 percent per year compared to .85 percent per year for the Standard & Poor's 500 stock market index.

This shows bonds can be a pretty good investment. Just remember, past performance does not guarantee similar results in the future.

Also, be aware bonds are by no means risk free, though the risk level usually is lower than what you get with stocks.