With less risk in bonds, there are certain periods of time when investors flock to bonds and reduce their stock investments. I am not saying that this is what will happen, but based on history it could happen. Therefore, why not position at least a portion of your portfolio for this event?

Furthermore, there is a widespread belief that stocks are overvalued. There are many arguments that discuss a "New Economy" and why stocks really aren't overvalued. I believe that at least some of this might be true. Having said that, is there still a strong likelihood that stocks will perform the way they have in recent years? A look at history suggests that this is unlikely.

One look at the graph below will show that as the Price to Earnings ratio (a measure of how expensive the stock market is) increases, the ensuing 10 years generate lower returns. When the stock market is expensive and you buy at high prices you guarantee yourself lower performance. When you buy at low prices, you're more likely to generate a higher return.

Therefore, with the stock market at a record P/E ratio, is there really a great reward for completely ignoring bonds? Given their lower risk and the fact that they have outperformed stocks during certain periods of time, I think that bonds should become at least a part of your portfolio.

Julia Curbo manages Portfolios 101, a web site dedicated to portfolio management, personal finance, and retirement planning.

06/22/00
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