Bonds' Bad Returns Throw Savings Master Plans Out of Whack

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

NEW YORK (TheStreet) -- It's one of the basic rules of investing: Divide your portfolio carefully between stocks, bonds and cash to find an ideal mix of risks and returns. But now, one part of that equation -- bonds -- is throwing the master plan out of whack.

The reason: Bonds now offer far more risk, and the prospect of lower returns, than at any time during the past three decades. Because of that, many investors may be wise to shift part of their bond holdings, perhaps a big part, into simple bank savings or other cash holdings. You won't make much money that way, but you'll protect your holdings from losses.

"The last 30 years you haven't had to make a choice in fixed income. It's given you great returns over and above inflation and low volatility. Now every dollar that goes into fixed income comes at a price of really reducing the expected return of the portfolio," says Michael Jones, chief investment officer and chairman of the RiverFront Investment Group, in a video interview with market-data firm Morningstar (MORN).

While many investors expect bonds to produce lower returns than stocks, they also assume bonds are safer. Ideally, they also march to a different drummer, producing positive returns when stocks are in the dumps. That reduces the portfolio's overall volatility, or risk.

But over the past three decades bonds have produced stunning returns, even though their yields, or interest earnings, have generally been nothing to brag about -- especially in recent years. With yields low, the big returns came from rising bond prices. As prevailing interest rates gradually got lower and lower, investors were willing to pay extra for older bonds that were more generous than newer ones. This process produced stock-like returns for many bonds and bond funds.

But now rates are so low they cannot go much lower, with the 10-year U.S. Treasury, for example, yielding just 1.75%. Bonds with shorter terms yield even less.

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