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Balancing Your Portfolio With Bonds

The pros and cons of investing in bonds

When financial advisors recommend maintaining a balanced portfolio, they don't mean investing 50 percent of your funds in a high-tech software firm and the other half in an Internet start-up. While that combination may have provided handsome returns at the end of the last decade, we're back in Kansas now, Toto, and it's time for a reality check.

Balance means diversification-stocks, bonds, cash-as a hedge against volatility. One investment option we've all heard of but know little about is high-yield municipal bonds. Municipal debt typically involves not-for-profit entities issuing debt for public projects or municipalities issuing debt backed by its taxing authority. In essence, they are debt securities that are issued to finance hospitals, utilities, airports and other essential facilities. Subsequently, municipal bonds, by serving a public purpose, have an underlying strength that helps explain why munis have shown a lower default rate over time compared to corporate debt.

Nevertheless, there are risks associated with high-yield municipal bonds. First of all, there is the risk that an issuer will become unable to pay its debt obligations. Then there is the chance that a bond's price will fall as interest rates rise. And finally, there's the lingering fear of not being able to find a buyer for bonds at or near the fair market value. Such risks can be tempered, however, by investing in professionally managed high-yield municipal bond funds. You can buy high-yield municipal bonds from any registered broker/dealer; just make sure you deal only with those who specialize in high-yield munis.

Consult with your investment or tax advisor before buying municipal or any other bonds to ensure the investment meets your financial objectives. For further information, contact The Bond Market Association (www.bondmarkets.com).

Paul DeCeglie (deceglie@smallbizmail.com) is a former staff reporter for Journal of Commerce and American Banker.

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