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 7