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Step 1
Decide whether your portfolio should be designed for minimal credit and maturity risk, or for maximum capital gains. Determine how soon you might need the proceeds. After age 50, you should add an increasing amount of money to bonds, rather than other asset classes, such as stocks.
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Step 2
Purchase from a family of funds that has low fees and that allows easy transfer of funds from one fund to another. The family of funds should also sweep any dividends into a money-market fund. You can redeploy interest income in the same proportion as your fund allocation.
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Step 3
Purchase an intermediate fund. If your tax bracket is above 20 percent, consider purchasing municipal-bond funds rather than taxable funds. For tax-deferred retirement accounts, always choose taxable funds. Intermediate funds invest out to 10 years and should be where the bulk of your funds are invested. Sixty percent of your monies should be put in intermediate funds. Intermediate funds capture about 85 percent of the return available from long-term funds, but only represent half the risk of longer funds.
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Step 4
Invest 20 to 30 percent of your assets in short-term funds that invest in the three- to five-year range. These funds represent maximum yields through the first five years of the interest-rate curve and tend to incur little interest-rate risk. Since the purchase of these funds is for preservation of capital, consider investing some of your short-term monies in government-backed debt, such as treasuries, agency debt or other AAA funds.
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Step 5
Judge whether interest rates are going higher or lower, and put between 10 and 20 percent of your funds in long maturities. Long-maturity funds have greater interest-rate risk, and thus more asset risk. In addition, as a result of interest-rate risk, many bonds are subject to a short-call feature that will reduce income during periods of low interest rates.
