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Bonds Reclaim Limelight After Stock Rout

But those searching for higher yields these days, are unlikely to remember the bond market lessons of the 1970s, when inflation pushed rates higher, and many bond buyers found themselves stuck with long-term bonds at yields that were way below inflation.

Before you start considering the role of bonds in your investments, you need to know some basics about the two risks in owning bonds.

The first is called "credit risk," or the risk that a company might default on its interest payments. You can usually minimize this risk by purchasing bonds with high ratings from Moody's (MCO - Get Report) and Standard & Poor's. And you can minimize your overall credit risk by owning a diversified group of bonds. The easiest way to do that is to buy a mutual fund, so that portfolio managers can pick bonds for you.

The second risk is related to interest rates. If you lend money for 20 or 30 years at a fixed rate, rising interest rates can make your bonds less attractive. In other words, if you buy a 20-year corporate bond that pays 5% today and the issuer sells more bonds at 7% tomorrow, your bonds will be worth less in the marketplace.

One more basic: The longer it takes for a bond to reach its maturity date, the bigger the price swing. After all, it's better to be stuck with a low-yielding bond that matures five years instead of 20.

Remember: As interest rates fall, bond prices rise, and vice versa. If interest rates were to rise sharply, amid fears of future inflation, bond prices would fall.
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