Bonds Still Vital to Portfolio

A sluggish economy combined with low interest rates makes things challenging for investors. Stocks aren't looking great -- they're down about 20% from their early October highs -- so many investors are wary of putting their money in equities. Yet, yields from fixed income investments remain low due to historically low interest rates.

Faced with this situation, many investors try to chase higher returns, either in the form of the latest hot stock pick, or higher yielding bonds. That's not always the best move, according to Greg Shultz, a principal at Asset Allocation Advisors, a financial planning firm located in California.

Instead, he says, the solution is to keep to a well-balanced, diversified portfolio -- meaning, one that includes an appropriate mix of both stocks and bonds. Bonds generate interest that will supplement your returns during a down market, and since bond prices are much less volatile than stock prices, bonds also keep your portfolio from plummeting if the stock market tanks.

"Truly great track records are not created in up markets, they're done in a down market," says Shultz. "By lowering your losses on a down market, you protect your capital and are better positioned to take advantage of a recovery."

Here's an example of how bonds can protect your assets during a stock market decline. The S&P 500 fell 9.45% YTD during the first three months of this year. An asset allocation account from Schwab(SCHW Quote) that aimed for 80% stocks and 15% bonds (the remaining 5% was in cash) declined only 7.55% over the same period.

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