Where To Put the Low Risk Part of Your Portfolio?

I've got a little over 13% of my total portfolio in bonds; to be honest, I've only got that much because everyone's conventional wisdom seems to be that part of your portfolio needs to be more conservative than equities, and should therefore be in bonds. I originally invested in a Vanguard Long Term bond fund and then later in total-bond-market ETF (AGG).

I did not put a lot of research into the bond side of my portfolio; lately I've wondered if it wouldn't be simpler just to put this part of the portfolio in cash. So I decided to check it out.

	2001	2002	2003	2004	2005	2006
Vanguard Prime Money Market	6.29%	4.17%	0.9%	1.11%	3.01%	4.88%
Vanguard GNMA	7.9%	9.7%	2.5%%	4.1%	3.3%	4.3%
Vanguard Long Term Bond Market	8.2%	14.4%	5.5%	8.4%	5.3%	2.7%
Vanguard Total Bond Market	8.4%	8.3%	4.0%	4.2%	2.4%	4.3%
AGG				3.99%	2.16%	4.13
TIP				8.27%	2.49%	0.28

Conclusions?

Cash is great, but as a part of your investment portfolio it's going to have a ceiling. That ceiling is probably somewhere around 6%, and you're only going to get that near the bottom of a market - exactly the point where your cash fund will lag bond funds.

The idea behind TIP funds is great; they help you negate the effects of inflation. But keep in mind that they are adjusted twice a year; the adjustment that helps you beat inflation will happen 6 months AFTER you're hit with the inflation. My original choice, the Vanguard Long Term Bond Market fund, looks pretty good here. It should - the long term bonds should in theory always give better yields than the short term funds.

A total bond market fund seems like a great idea, but as you can see a total market fund can lag a long term bond fund in some years. BUT - either a total market fund or a long term bond fund is going to have a higher ceiling than a money market cash fund. It can pay to do your research on total bond funds; a check of Morningstar reviews shows that the index used to create the AGG ETF is a much smaller index than the one Vanguard uses to create their total bond market fund. That could imply that you could get higher highs (but perhaps lower lows?) with a total bond market fund.

Bond funds are even easier to invest in now. There are now iShares bond ETFs and Vanguard bond ETFs.