Bonds Primer: How Much to Buy

How much of your portfolio should you put into fixed income? We'll point you in the direction of piece, depending on your tax bracket, a municipal bond may give you a higher after-tax yield.

The main downside of zeros: If interest rates rise after you buy them, you can't ease the pain by reinvesting your coupon income at the higher rates, because there isn't any coupon income.

That feature is why the prices of zero-coupon bonds fall faster than those of coupon-bearing bonds when interest rates rise. If you had to sell your zeros before they matured -- and interest rates had risen -- you'd lose more on them than you would for coupon-bearing bonds.

If, for example, you'd bought that strip we mentioned above at the beginning of 1994 for $181.17, you would subsequently have watched it fall to $151.17 by the end of that terrible year for bonds, for a total negative return of 16.6%. During the same period, the price of a comparable coupon-bearing bond would have fallen 14.8%. But taking the income into account, the coupon bond's total return for the year would have been minus 8.3% -- much, much better than the zero-coupon bond's.

The upshot: Don't buy zeros for savings if you may need to sell.

>To order reprints of this article, click here: Reprints