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investing 101How to buy bonds
Lessons:
1
 
Aiming for a realistic return
2
Identifying your real risks
3
Putting together the right portfolio
4
The psychology of investing
5
Investing for growth
6
Seven questions to ask before buying a growth stock
7
How to spot value
8
Selecting stocks for income
9
How to buy bonds
10
Preferred shares: uncommon values
11
Convertibles: the best of both worlds
12
Closed-end funds: their time will come again
13
The right way to use stock options
14
Mergers and acquisitions
15
Frequently asked questions I
16
Frequently asked questions II
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The stock-picking bug is powerful. But not only do bonds sometimes outperform, the proper allocation can boost your overall returns.

Even if you're primarily a growth stock investor, you shouldn't neglect bonds. In fact, there's a strong case for keeping as much as 25 percent of your portfolio in an assortment of fixed-income investments. Primarily, bonds will greatly limit your losses in a market decline. Treasury bond prices have been rising even as most growth stocks have been falling over the last year. With that safety net, you can afford to invest some of your money more aggressively, which can actually end up boosting your overall profits.

On average, long-term Treasuries have returned only 6 percent per year compared with 12 percent for S&P 500-stocks. But the gap isn't always that big. When stocks start from very high valuations (like those of the past few years), their future returns may average only 7 or 8 percent a year -- and there may be several years in which stock prices plateau. Similarly, bonds can return a lot more than 6 percent if you buy at the right time -- usually right before the economy slows and interest rates fall, which pushes up bond prices. Here's a look at the key income choices.

Treasury bonds are fully backed by the U.S. government, so the chance of default is nonexistent. Prices may rise and fall, but all interest payments will be made on time. Another plus is that those payments are exempt from state and local taxes. The bonds of government agencies, such as the Tennessee Valley Authority, are nearly as safe as Treasuries and they pay slightly more. Ginnie Maes, which pass through the interest and principal payments made on mortgages, also pay more than Treasuries.

Tax-exempt municipal issues are often great buys for people in top tax brackets. Over the past couple of years, in fact, municipal yields have been close to Treasury yields even without the tax advantage.

Corporate bonds pay higher yields than government issues, with top-quality issues generally offering at least a percentage point more than Treasuries. And low-quality corporates, known as junk bonds, can yield 10 percent or more. With higher interest payments, however, comes a greater risk of default, so it's crucial to diversify.

Once you've settled on the type of bonds you're looking for, the chief question is whether to buy them directly or through mutual funds. Since fund expenses can be killers, one rule of thumb is to use funds only when professional management and broad diversification are essential. That's certainly true for junk and foreign bonds, and usually for munis as well. Index funds, with their rock-bottom fees, are a valid choice for any type of bonds. But for Treasuries and other high-grade debt, consider direct purchases through your brokerage account.

Preferred shares: uncommon value >>

 

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