Bonds have gotten a lot of attention over the past year and it’s easy to see why when you look at this chart.

What you’re looking at is a relatively smooth ride up until the world collapsed in October of 2008. The investorspeak for that smooth ride is “low volatility”, and it’s one of the main traits of bonds in general, when compared to stocks. But 2008 was anything but usual, and once panic hit the markets bonds collapsed just like stocks. It was a sensible panic in many ways. After all, no one was really sure what the true debt picture was and bonds are nothing more than debt that the debtor has agreed to pay back in a timely, and consistent fashion with interest. But what if the debtor suddenly wasn’t as financially stable as you were led to believe? What if the bond ratings were smoke and mirrors, and your bond wasn’t worth the proverbial paper is was once printed on?

The good and the bad.

So, you see around October, 2008 the steep drop in the prices of these bond funds.

So far, so good. That’s the unusually bad angle. The unusually good side of the picture comes in the months after the market bottomed, around March, 2009.

• BJBHX saw a return of approximately 45% from its March 2009 lows.
• FRHIX saw a return of approximately 15% from its March 2009 lows.
• PRHYX saw a return of approximately 40% from its March 2009 lows.
• DODIX saw a return of approximately 13% from its March 2009 lows.

(More on the individual returns below.)

Bond funds don’t usually produce these kinds of returns, unless they’re junk bonds but they’re (usually) much riskier.

Are bonds still a good buy?

In a sense, all that stellar return was simple the market realizing the world was not coming to an end, and returning back to the norm. The chart above bears this out rather nicely.

So, it would seem that the major upside potential for bonds has played itself out and we have returned to something at least resembling normalcy. But that doesn’t mean that you should avoid bonds. You just shouldn’t be expecting the kinds of return seen in bonds over the past 8 months or so.

Meet the bond funds.

These bond funds come from 3 different categories, which in part explains their diverse returns. These categories are Municipal, High-yield (A.K.A. Junk), and Corporate bonds.

Municipal Bond fund.
My pick for municipal bond fund is the Franklin High Yield Tax-Free Income fund (FRHIX). This fund current yields about the same as 9.4% in a taxable fund (assuming a 35% federal income tax bracket). Tax free municipal bond funds don’t usually see a return of 15%, so this fund has definitely been a winner for those looking for tax free income because they’ve also gotten a very nice return on their investment along with the income.

High-yield bond fund.

Often times, bonds in this category are less than affectionately known as “junk”, but the Artio Global High Income (BJBHX) fund is far from junk. It boasts a 5 star Morningstar rating, and should be viewed more as a speculative, or higher risk bond fund than as junk. It currently sports a 7.4% yield, 1.00% expense ration and it delivered an eye popping (for a bond fund) 45% return from its March 2009 lows.

Another very good high yield bond fund is the T. Rowe Price High-Yield fund (PRHYX), which has a 4-star rating and a yield of 8.5%. It also delivered an eye popping return since its March 2009 lows – 40%. It has a 0.80% expense ratio, which isn’t bad considering its category.

Corporate bond fund.

My choice for corporate bond fund is the 5-star Dodge & Cox Income fund (DODIX). This fund has a 5.22% yield, 0.43% expense ratio and produced a relatively small 13% return. But remember – 13% is usually the realm of high-yield/junk bonds, but this fund is a corporate bond fund that targets only those rated A or better by either Standard & Poor’s Ratings Group or Moody’s.

Conclusion.

It would seem that the wild ride in bonds is over, at least for a while. So you shouldn’t expect such remarkable returns from these bond funds in the foreseeable future, but they are at the top of their class and should still provide a stable income in the years to come.

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The Vanguard family of funds has many fans in the individual investor community. With their dedication to low expense fees, it’s no surprise. Much has been made of the drag on performance of high fees, and there is a growing investment community that not only shuns investments with high fees, but rates fees and expenses high on the list of things to consider when choosing an investment.

For those of you who count yourselves among this lot of fans, here is a sample ETF portfolio that is entirely Vanguard funds. The average annual expense ratio of this portfolio is just 0.13%! It’s geared toward the average risk tolerance with a 65% stock – 35% bond split.

• 35% Vanguard Total Bond Market (BND)
• 20% Vanguard FTSE All-World ex-US (VEU)
• 20% Vanguard Large Cap (VV)
• 15% Vanguard Small Cap (VB)
• 5% Vanguard Emerging Markets Stock (VWO)
• 5% Vanguard REIT (VNQ)

BND

Seeks to track the performance of a broad, market-weighted bond index. The fund invests by sampling the index.
EXPENSE RATIO:0.14%
YIELD:4.44%

VEU

Seeks to track the performance of the FTSE All-World ex-US Bond Index (foreign bonds).
EXPENSE RATIO:0.20%
YIELD:1.83%

VV

This fund employs a passive management investment approach designed to track the performance of the MSCI US Prime Market 750 index, a broadly diversified index of the stocks of predominantly large U.S. companies.
EXPENSE RATIO:0.07%
YIELD:2.00%

VB

This fund employs a passive management investment approach designed to track the performance of the MSCI US Small Cap 1750 index, a broadly diversified index of the stocks of smaller U.S. companies.
EXPENSE RATIO: 0.10%
YIELD:1.64%

VWO

This fund employs a passively managed investment approach by investing all or substantially all of assets in a representative sample of the common stocks included in the MSCI Emerging Markets index.
EXPENSE RATIO: 0.20%
YIELD:3.07%

VNQ

The Vanguard REIT ETF tracks the Morgan Stanley Capital International (MSCI) US REIT Index.
EXPENSE RATIO:0.11%
YIELD:5.58%

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With the low fees and wide selection of ETFs, you can now build a portfolio for maximum and minimum fees relatively easily. Here’s one such sample portfolio from Kiplinger that allocates 65% to bonds, 35% to stocks. The bond section is spread between conservative, laddered treasures and riskier junk bonds. As of a month ago, the yield for the portfolio was 6.4%. Not too shabby when you consider inflation is practically non existent and you can lock your money up for 10 years in treasury notes for a measly 3.6%.

• 25% iShares iBoxx $ Inv Grade Corp (LQD)
• 15% iShares iBoxx $ High Yld Corp (HYG)
• 15% PowerShares Em Mkts Sov Debt (PCY)
• 15% Vanguard REIT (VNQ)
• 10% iShares DJ Select Dividend (DVY)
• 10% PowerShares 1-30 Laddered Treas (PLW)
• 10% Utilities Select Sector SPDR (XLU)

LQD

The iShares iBoxx $ Inv Grade Corp ETF tracks the iBoxx $ Liquid Investment Grade Index.
EXPENSE RATIO:0.15%
YIELD:5.30%

HYG

Seeks the results that correspond generally to the price and yield performance, before fees and expenses, of the iBoxx(Reg. TM) $ Liquid High Yield Index. The fund invests at least 90% of assets in securities that comprise the index. However, it may invest up to 20% of assets in certain futures, options and swap contracts, cash and cash equivalents, and in bonds not included within the index
EXPENSE RATIO:0.50%
YIELD:9.78%

PCY

This fund normally invests at least 80% of total assets in emerging markets U.S. dollar-denominated government bonds.
EXPENSE RATIO:0.50%
YIELD:6.08%

VNQ

The Vanguard REIT ETF tracks the Morgan Stanley Capital International (MSCI) US REIT Index.
EXPENSE RATIO:0.11%
YIELD:5.58%

DVY

The iShares DJ Select Dividend ETF tracks the Dow Jones Select Dividend index.
EXPENSE RATIO:0.40%
YIELD: 4.32%

PLW

This fund normally invests at least 80% of total assets in U.S. Treasury securities.
EXPENSE RATIO:0.25%
YIELD:3.56%

XLU

INDEX:The Utilities Select Sector SPDR ETF tracks the S&P International Dividend Opportunities index.
EXPENSE RATIO:0.48%
YIELD:3.57%

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To Mary Beth Franklin, editor of Kiplinger’s magazine, it also suggests a new way to view near retirement and post-retirement investing. It puts emphasis on what she calls “Reliability of Income”. Mary Beth suggests that retirees divide their assets into 3 buckets:

Bucket 1:

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Bucket 2:

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Bucket 3:

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High-yield bonds.

T. Rowe Price Spectrum Income (RPSIX)

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Intermediate-term bonds.

Metropolitan West Total Return Bond (MWTRX)

The management team of Stephen Kane, Laird Landmann, and Tad Rivelle have been at the helm of this fund since 1997, and with excellent results. The team focus on a selective group of bonds including BB and B rated, higher yielding issues and bank loans. However, they also placed a contrarian bet on commercial and residential mortgages in 2008, so this fund is not for the impatient or conservative investor.

FPA New Income (FPNIX)

Here’s a more conservative fund. Manager Bob Rodriguez has maintained a “buyer’s strike” against high-yield bonds and U.S. Treasuries, and has a sterling long-term record. One item of note however: Rodriguez plans to take a one year sabbatical starting January 2010, but he is passing control of the fund to Thomas Atteberry, the fund’s co-manager.

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Looking for an easy, diversified portfolio of stock funds that will grow your money over time, but won’t take over your life with demands on your time? ladies, gentlemen and undeclared’s, I present the simple 7 portfolio..

Each recommendation is either an ETF, or a no-load mutual fund. Some people prefer mutual funds, and others ETFs, but there is little difference here. Most are also index tracking funds, so they are relatively low maintenance – for the set it and forget it, long term buy and hold investor. Most expense ratios are under 1%

The Simple 7 Portfolio.

1. A blue-chip U.S.-stock fund.

• iShares S&P 500 Index (IVV )

• Selected American Shares (SLASX)

• Fidelity Spartan 500 Index (FSMKX)

2. A blue-chip foreign-stock fund.

• Vanguard Total International Stock Index (VGTSX )

• Vanguard FTSE All World Ex-U.S. ETF (VEU)

• Dodge & Cox Intl. Stock (DODFX ) .

3. A small-company fund.

• Vanguard Small-Cap ETF (VB ).

• T. Rowe Price New Horizons (PRNHX)

• Vanguard Small-Cap Index (NAESX)

4. A value fund.

• iShares S&P 500 Value Index (IVE)

• Vanguard Value Index (VIVAX)

• T. Rowe Price Equity Income (PRFDX)

5. A high-quality bond fund.

• Vanguard Total Bond Market ETF (BND)

• Vanguard Total Bond Market Index (VBMFX)

• Harbor Bond (HABDX)

6. An inflation-protected bond fund.

• Vanguard Inflation-Protected Securities Fund (VIPSX)

• T. Rowe Price Infl.-Protected Bond (PRIPX)

• iShares Lehman TIPS Bond (TIP)

7. A money-market fund.

• Fidelity Cash Reserves (FDRXX)

• Vanguard Prime Money Market (VMMXX)

• Schwab Value Advantage Money (SWVXX)

I leave the actual asset allocation to you, since that will depend on your time horizon, risk tolerance and so forth.

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