TSC Schoolhouse: Bonds Primer: Why Bother with Bonds?

Would you accept a somewhat lower return if it meant considerably less risk? If so, you're in the market for bonds. Lowering risk is basically what bonds are all about.

Bonds aren't foolproof. It's possible to lose money in bonds. In 1994, the worst year for bonds in a generation, lots of investors learned that lesson. Interest rates rose so much and so quickly that the paper price losses on many bonds were greater than the income they generated.

But 1994 was probably close to as bad as it gets. Over the long term, bonds have produced healthy returns -- much higher than money market funds have, and respectable even compared with equities. From 1987 to 1997, measuring from year-end to year-end, the Merrill Lynch Treasury Master Index returned an average of 8.9% a year, and Merrill's U.S. Corporate Master Index of investment-grade corporate bonds returned 10.1% a year. Those figures compare with average annual returns of 18.1% for the S&P 500 and 5.5% for taxable money market funds. ...