Think, Act, and Invest Like Warren Buffett – The Winning Strategy to Help You Achieve Your Financial and Life Goals : [PDF Download]

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“Bonds have two risk factors: term (number of years to maturity) and default (credit). The longer the term to maturity and the lower the credit rating, the greater the risk and expected returns.

So you need to decide how much you will allocate to high-quality versus lower-quality bonds, and how much you will allocate to short-term and intermediate-term bonds versus long-term bonds. Before you tackle the type of bonds to own, it is critical that you understand the role bonds should play in a portfolio.

The central role of bonds in a portfolio should be to dampen the risk of the overall portfolio to an acceptable level, which means you should minimize risks in your bond holdings. That makes the investment decision simple.

A basic rule of thumb is to limit your holdings to FDIC -insured CDs and the safest bonds, those that carry the full faith and credit of the U.S. government, and highly rated (AAA/AA) municipal bonds.

If you choose to own corporate bonds (which entail more credit risk), the historical evidence suggests that you limit your holdings to those with remaining maturities of three years or less and to bonds that have investment-grade ratings (a rating that indicates that the bond has a relatively low risk of default). These guidelines simplify your decision.”

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