Free Wealth Management Guide Building An Effectively Diversified Investment Por | Page 7

In general, bonds with lower credit
quality will offer a higher yield. As you
can see in the chart to the right, however,
bonds with lower credit ratings (such as
BBB and high-yield bonds) do not tend
to offer enough extra return potential
over higher quality bonds to justify their
additional risk.
There are two key lessons to be derived
from these charts. One is that shortterm, high-quality bonds should do a
better job of decreasing the volatility of
an overall portfolio than other types of
bonds because their prices are more stable.
That stability can help reduce a portfolios
amount of price fluctuation. The other is
that it may not be worth taking the risk of
generating higher returns by owning longterm, low-quality bonds.
As you can see in the graph below,
changing the bond allocation to that of
Portfolio Two, the return stayed about
the same while achieving a reduction in
standard deviation.

Portfolio Two

January 1970 - December 2012
Annualized
Return

Portfolio One
Portfolio Two

Annualized
Standard
Deviation

Growth of
$100,000

8.5%
8.4%

11.6%
11.0%

S&P 500
60%

Short/Int.
Bonds
40%

$3,281,865
$3,249,085

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