Bonds have a place in virtually every investor’s portfolio because (1) their prices are generally less volatile than stocks, (2) they offer a fixed stream of cash flow and (3) they have a stated maturity date and value.

They also help create a balanced portfolio for combating the erosive effects of volatility as well as inflation. The key is to determine whatpercentage of bonds to own and what type based on your personal financial needs and investment objectives.

Generally, investors in their 20s may allocate up to 100 percent of their funds to equities and, as they age, adjust this allocation according to their risk tolerance and reliance on investment income to meet their financial obligations. For instance, a combination of the desire for safetyand the maximization of income is common among many first-time bond buyers.

These investors seek to accomplish their objectives by investing in a variety of bond types such as U.S. Treasury securities, agency notes, andFDIC-insured CDs. Agency notes currently offer the highest yields.Treasuries offer maximum safety. CDs provide both a governmentguarantee and a greater yield than Treasuries, but are insured up to a maximum of $100,000.

Investors who seek to stabilize the income from their portfolios can also use a combination of bond types, including corporate bonds, mortgage securities, agency notes and preferred securities. These securities canoffer a diversified mix of credits from government sponsored agencies, to large industrialized credits, a finance company, and even a REIT. This typeof “reliable income” is essential to many retirees who depend on their investment portfolios for cash flow.

It is important to note that these types of bonds also have varying maturity dates which help to stabilize the market risk in a portfolio as prices of longer maturity bonds will fluctuate at a greater rate than shorter maturities. In addition, staggering the maturity dates eliminatesthe dilemma of investing all funds in a low rate environment or not having any funds to invest when interest rates rise.

Finally, investors who wish to maximize the potential for price appreciation are best served by adding STRIPs (zero coupon bonds) to portfolios that have the credit safety and liquidity of Treasury securities.

Investors should be aware that while they will not receive income from the STRIPs, they will be required to pay federal income taxes (but not state) on the accrued income each year.

(Alan S. Moore is a financial advisor in the New Orleans office of LeggMason Wood Walker, Inc., a diversified securities brokerage and financialservices firm that is a member of the New York Stock Exchange, Inc. andSIPC.)

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