Matching bonds to investor requirements

For added security, look for insured muni bonds, which guarantee principal if the issuer defaults. Munis and corporate bonds are graded on creditworthiness, with AAA being best. Stick to AAA if you can.

Corporate bonds: Many investors also allocate some dollars to these. Corporates pay higher interest than comparable Treasuries but are fully taxable and have greater credit risk.

Corporate bonds are unique in that their value is less sensitive to interest rates and more linked to the issuer's financial fortitude. For instance, a bond issued by General Electric would pay a lower interest rate than one from a small, unknown company. Because of GE's size and strength, investors would have more confidence that their money would be returned, so they'd accept a lower yield for the GE bond.

Junk bonds: When companies of lesser quality or in unproved industries tap the debt markets, investors demand higher yields to cover the risk that those borrowers will go bankrupt. These bonds are known as high-yield or junk bonds, and they act more like stocks than standard bonds.

They won't rally when interest rates fall, nor lose much when rates rise. As such, they're less volatile than longer-term Treasuries. For that reason, they can cushion a portfolio in a way other types of bonds can't. On the other hand, junk bonds also increase your portfolio's exposure to default risk.

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