But whether stocks constitute 80, 60, or 40% of your assets, the question that gets overlooked is: What the heck are you supposed to do with the rest of your money? Do you put it into U.S. Treasuries...corporate bonds...municipal bonds...bond funds... zero coupon bonds?

The term often used for nonequity assets is "fixed income." And too many people assume that fixed income assets are all the same, and it's only the stock part of the portfolio that demands your time and attention.

Not so. Sure, fixed income is supposed to be less risky, its main function to produce more predictable cash flow. But it's not an area to be ignored.

1. Helping you to hedge your bets. Often (but not always), bonds go up when stocks go down.

2. Providing a steady source of income. This is an especially welcome treat in your retirement years.

3. Cutting your taxes. Bonds can provide income in a tax-advantaged manner.

Later, we'll suggest particular investments and review certain fixed income strategies for lowering your taxes. But first, let's examine some of the options available in the fixed income area.

When looking at nonequity assets, start with cash. Well, actually you shouldn't have too much cash lying around. Put it in a money market fund. Check around to see who has the best rates.

1. Creditworthiness. You want a bond whose issuer isn't going to default. Your chance of getting your money back when the bond matures is tied to the creditworthiness of the issuer.

For this reason, U.S. Treasuries are absolutely the safest fixed income assets from a credit standpoint. They're backed by the full faith and credit of the U.S. government. If these guys default, we're all in trouble.

Next up in terms of creditworthiness are municipal bonds. These are issued by state and local governments.

Finally there are corporate bonds. Some are real safe. Some are so risky they're commonly termed "junk."

To find out the creditworthiness of a particular bond issue, look up its rating with the various ratings agencies, such as Moody's or Standard & Poor's. The worse the rating, the worse the risk, but the higher the interest rate.

2. Capital appreciation on the upside vs. capital loss on the downside. In other words, will you get your money back...and then some? Or could you even end up losing some of your principal?

The value of your bonds can go up...or down...depending on what interests rates do. When interest rates go up, the value of your bonds goes down, because investors can get a higher interest rate by buying new bonds.

When interest rates go down, the value of your bonds rises. But keep in mind, with bonds you're generally looking for annual income as opposed to capital appreciation. Still, on occasion one can find fixed income assets that will make plenty of money beyond just the straight income.

3. Annual income per dollar invested. Another way to put this is: What is the yield of the investment? Yield is equal to annual income divided by the amount of your investment. Now, if you buy a bond at issue and keep it until maturity, the yield will be the same as the coupon rate — which is simply bond-speak for "interest rate."

But suppose you buy a bond on the secondary market. The yield will be the same if you buy the bond at par value and hold until maturity. But if you buy the bond at a premium, the yield will be less than the coupon rate.

You can compute the yield by dividing the annual income by your investment. Say you buy a 5% bond with face value of US$10,000 for US$10,500. The annual interest is US$500. The yield is therefore 4.7%.

4. How long your money will be tied up. In other words, what is the duration of the bond? You might be holding the bond to maturity. Or the bond might be "callable," meaning the issuer may have the right to force you to redeem the bond before maturity. In addition, you can always sell a bond on the secondary market. For more (or less) than your initial investment.

Long-term bonds are those with maturities of 10 years or more. Intermediate term means five to seven years. Most analysts suggest that the average investor should stay away from long-term bonds. The return you can get from intermediate term is about 80% of long term, without as much risk. They don't dive as quickly as long-term bonds when rates go up. On the other hand, if you feel strongly that rates are going to go down, long-term bonds are a good investment, as long as you get out of them before rates bounce back up.

The yield generally increases the longer the term of the bond. But that's not always the case. In fact, at the moment, longer term bonds are yielding less.

So why would anyone buy the longer term bonds now?

Simple: if you think rates will drop, you want to lock in those rates for a longer period. The so-called "inverted yield curve" means most people think rates will drop.

5. The tax impact of your investment. Always, always, always look at the after-tax return on your investment. What this means is: how much money is left after the IRS and the state and local tax authorities take their cuts.

Income from U.S. Treasuries is not taxable at the Federal level, but is generally taxed by states with income tax. So if you live in one of the 41 states that impose a tax on interest income, you can save by buying Treasuries.

Municipal bonds and other types of tax-exempt bonds are exempt from Federal tax, and generally from state tax, if the holder is a resident of the issuing state.

Well, you need to equate the yields. You know, compare apples to apples, kumquats to kumquats.

So you need to translate everything to its taxable equivalent. With the corporate bond, that's easy. Just the taxable interest, ma'am. But hold on. What if we put that bond in a retirement plan? Can we assume it will be treated like a muni, thereby enhancing its yield?

Not quite. Remember, this interest is likely to be taxed at some point. Unless you're using a Roth IRA, and the money's already in there (so you don't take into account you're losing a deduction). Problem with that: Roth is limited to US$2,000 a year, and corporate bonds are often sold in big bunches.

If the money will eventually be distributed, you have to figure at what rate it will be taxed and the present value of that money. Delaying payment is a help. But you don't know what the tax rates are going to be when you get it.

For Treasuries, you just divide the taxable yield by [1 minus your "effective tax rate."] Then multiply that result by the yield. The effective tax rate is your top marginal rate. For the purpose of U.S. Treasuries, which are exempt generally only from Federal taxes, we're talking you're highest Federal income tax rate: 15%, 28%, 33%, 36%, or 39.6%.

But with munis that are exempt from state, local and Federal taxes, it's a bit more complicated.

You start with adding the highest marginal Federal rate to the highest marginal state rate.

But this muni income, while reducing your state tax, also reduces your itemized deductions on your Federal income tax return.

You can deduct your state income tax if you itemize on your Federal return. Thus, each dollar of state tax you're saving is costing you some Federal tax.

There's an equation to figure all this out:

[Federal tax rate plus state tax rate] minus [state tax rate times federal tax rate] times yield.

Unless the bond is in a retirement account, gains and losses from bonds are taxable. That even applies to muni bonds and Treasuries.

Now, if you buy a bond at par and sell it at par (or hold it until maturity) you'll pay no tax. But you still have to report the proceeds on your tax returns. You'll simply show that the cost and the proceeds are the same, with 0 gain or loss.

Par is normally stated as 100, or 100% of the price. If you buy the bond at 110, or 110% of the issue price, you're buying the bond at a premium. If you buy it at 90, or 90% of the issue price, that's a discount. Suppose you buy it at 90 and sell it at 110? In that case you have a capital gain on which you have to pay taxes.

You can have a loss too. Say you buy it at par and sell it at a discount on the secondary market. That is a capital loss, as useful to you on your tax return as a loss on a stock. Even if you don't have any gains, you can deduct up to US$3,000 in losses every year, and carry over to future years any additional losses.

Here's an opportunity for you to cut your taxes yet still enjoy the benefits of receiving bond income. You can sell your bond at a loss and buy back a similar bond at the same time. This is called a bond swap.

But if you've been paying attention to our tax advice over the years, something should bug you about this.

Namely...that annoying "wash sale" rule. That's the tax rule that says you can't take a tax loss if you sell the losing investment and buy back an identical one within 30 days before or after the sale.

So in the case of that bond you're holding, how do you get around the wash sale rule?

You could wait 31 days before buying another bond. Or you could buy a bond that isn't "substantially identical" — which isn't hard to do when it comes to bonds.

1. Try the two-year Treasury.The ten-year Treasury note was yielding 6.02% as of July 10. The 30-year bond is at 5.88%. And five-year notes were yielding 6.12%. But two-year notes were at 6.29%. Why? The Fed has bought up longer term Treasuries, leaving a smaller supply. Meaning that prices are high but yields are low. Also, the Fed has boosted short-term interest rates.

2. Buy intermediate-term municipal bonds if your state has an income tax.This is a good time to buy munis, but it may not last. Yields are still increasing, and supply is shrinking. As more and more people cash out of the stock market, they will be looking to get into munis.

If you keep your eyes open you might be able to find a premium bond yielding more than discount bonds. You would figure this couldn't happen, that the bond market would force all yields to come into line. But the muni market isn't as dominated by investment professionals as other bond markets. And relatively naÔve individuals often shy away from buying munis at a premium.

So bargains could be available in your state.

3. Buy a short-term muni bond fund.You have a choice of how to invest in bonds: Bonds themselves or muni bond funds. If you don't have enough money to buy individual bonds, you may want to consider muni bond funds.

The biggest disadvantage of bond funds is that when you sell you may incur a loss. This would apply if you sold a bond before maturity. Of course, you may also enjoy a capital gain.

With a bond, you know how much you're getting back if you hold to maturity. With a bond fund you never know for sure how much you'll get. But if you limit it to short term, then you'll have a pretty good idea of the range. For example, the T. Rowe Price Maryland short-term bond fund has hovered between 5.07 and 5.15 for years. That's a pretty tight range.

In choosing bond funds, look at the fees. Expenses, such as management fees and overhead, should not exceed US$1.50 per US$100.

4. Buy a zero coupon muni or Treasury.These can give you a greater return — but with more risk. With a zero coupon bond, you don't receive any interest until the bond matures. Instead the interest is reinvested in the bond, compounding annually. Other bonds often pay twice a year. With zero coupons, you don't have to worry about reinvestment risk. But the value of a zero coupon bond tends to fluctuate more than that of other bonds. So there's more risk involved. If rates fall, the value climbs; when rates increase, value plummets. If you believe rates have peaked, now's the time to buy.

Income from these bonds is taxed each year even though you don't get the cash until maturity. So if you live in a state with income tax, not only is there no tax advantage on an annual basis, but you suffer from a cash-flow standpoint. A zero coupon can be a convenient financial planning device. You can choose a maturity term so the bond will come due when you need the money.

For more information on bonds, go to the website of the Bond Market Association, www.bondmarkets.com.

Check out U.S. Tax & Privacy's comprehensive list of tax-related links.