Bonds - Why do we own them?

Bonds are worth owning. Yes, the credit markets are a mess and bonds did fall in value during the Second Quarter 2008 but bonds offer stability. Bonds are much less volatile then commodities, stocks and residential real estate. See the adjacent chart. Bonds have a standard deviation of only 1.1% while oil's is over 9%. Standard deviation measures how scattered the returns are from the average. The more variation the higher the standard deviation. The down side is bonds earn less than stocks. So even though stocks are more risky in the long run they generate a higher return.

I view bonds as an insurance policy. How much long term return do you want to give up to gain stability? You are essentially buying an insurance policy for your portfolio the way you would for your home. In the case of property insurance, the question is how much current income are you willing to spend to protect you home from a catastrophic event. You are never going to make as much money invested in bonds instead of stocks. So how much do you need to invest in bonds to protect your portfolio from a catastrophic event? That depends on whether you need the money now or are years away from retirement. It depends on how well you can handle short term market swings. It depends on how much money you have and how much money you'll need and when. So the answer is it depends on your needs and your money personality. In other words, there is no magic formula. So it is important to carefully address all these issues when determining your allocation to bonds.