Feb. 11, 2003 — Faced with a three-year-old bear market, people have been abandoning stocks and embracing bonds in droves.
But investors shouldn’t lose sight of a principle that applies to buying both: the need to diversify. Owning debt instruments of different issuers and maturities can help minimize risks given the current juncture.
“You tend to limit your losses on the downside when you’re in many sectors of the (bond) market,” says Edmund Notzon, III, a bond fund manager with T.Rowe Price Group (TROW).
Notzon recommends that, in general, investors hold 80%-90% of their fixed-income assets in investment-grade bonds. These include corporate bonds as well as securities offered by the Treasury and government agencies.
Professionals say high-yield, or junk bonds, should be included in fixed-income portfolios because they can boost yields. However, they caution against allocating more than more a relatively small portion of your assets here.
“Ten percent to 20%, I think, is plenty,” says Notzon. “Because more than that and you’re definitely going to be increasing the volatility of your portfolio, and you might be inclined to bail out of it if it has a period of substantial underperformance.”
Junk bonds have not done as well as investment-grade securities over the last few years. Because of that, though, they have become cheap and now “represent a good value,” Notzon says. High-yield bond funds as tracked by Standard & Poor’s lost 0.9% in 2002, but gained 6% in the fourth quarter, and another 2% in January.