Re-thinking the Income Component of Your Portfolio

Diversified portfolios are generally split in some measure between growth-oriented and income-producing assets. With the stock market alternating between 20% declines and 20% rallies over the course of just a few month, there are certainly some agonizing decisions to be made about the growth component. However, there are also important decisions to be made about the income side of your portfolio.

When it came to income investments, over the past thirty years bonds have made more sense for the typical portfolio than shorter-term vehicles like money markets or certificates of deposit. The reason was two-fold. First, the normal yield curve is such that longer-term vehicles pay more interest than shorter-term ones. Second, longer-term bonds lock in income levels for a longer period of time than money markets or certificates of deposit.

However, with interest rates having fallen so much, it's time for a fresh look at the income side of your portfolio. Bonds issued over the past several years, when interest rates were higher, are now trading at substantial premiums over par, and these premiums would disappear if interest rates rise. Further, locking in income levels at today's low interest rates isn't necessarily a plus. Finally, with 10-year Treasury yields now down below 3%, going longer doesn't necessarily offer that much of a premium.

Searching for the best CD rates will earn you almost as much interest, without the volatility risk of bonds and with greater flexibility to reinvest if interest rates rise.

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