In the summer of 2004 I wrote a series of articles for TheSteet.com, the financial Web site co-founded by CNBC’s Jim Cramer. I had grown increasingly worried about the poor lending practices at the time and the fact that it seemed like everyone was bragging about his or her home’s price appreciation, which seemed outrageous to me—as beautiful as it is in the South Bay, it seems there should be reasonable limits one pays for a home despite year-round sunshine, beautiful surroundings and beach access. Anyway, it was apparent to me that we were in a housing bubble, and the enthusiasm reminded me of the technology/Internet bubble of the early 2000s.

Two of the articles I wrote in July and August of 2004, offered strong warnings about the coming housing collapse and the devastation it would cause to stocks, real estate and other asset classes. I basically wrote “there was no place to hide.” Remember, this was five years ago, when most investors weren’t terribly worried about losing money in stocks or real estate. The articles were titled “Protection Against a Housing Collapse” and “Nowhere to Turn in this Rate-Hike Cycle.”

While I stressed protecting wealth before the coming decline in stocks and real estate, I was wrong about my “there was no place to hide” call. Other than CDs or cash, there was a great place to “hide,” in short-term corporate bonds. Short-term bonds, which mature anywhere from 1-5 years, are simply a loan you make to a corporation and it agrees to pay you an income stream (certain percentage coupon) typically twice yearly. At maturity, assuming no default by the issuer, you will have received all your income payments and repayment of your principal. The yield-to-maturity at the time of purchase tells you the exact percentage return you can expect if held to maturity.

During the recent bear market in stocks, real estate and other asset classes, short-term investment-grade corporate bonds have provided fairly steady returns without the volatility and risks associated with other asset classes. The Vanguard Group has a couple of short-term bond funds that performed admirably during this period. I’ve chosen Vanguard’s offerings for comparison purposes because they are the best-known provider of low-cost funds. Vanguard’s Short-Term Bond Index Fund (symbol VBISX) returned 3.7% on average the past 5 years and 5.7% on average over the past 3 years. Since inception in 1994, it has returned 5.3% averaged annually. Vanguard’s Short-Term Investment-Grade Fund (VFSTX) also held up well during this period, earning 2.1% on average the past 5 years and 2.4% during the past 3 years. Its average annual return since inception in 1982 has been 6.8%.

While Vanguard’s low-cost offerings are an attractive alternative for many investors, my preference is for investors to build their own portfolio of individual bonds. Corporate bonds are available for purchase at all major brokerage firms and are typically offered in tranches of 10 bonds (approximately $10,000 in most cases) but some dealers have minimums that are even lower (1 to 5 bonds).

Over the years I have constructed many bond ladders and lately I’ve been focused on building short-term investment-grade bond portfolios for clients who have moderate-risk profiles, but want potential returns in excess of money markets and CDs. I think building a bond ladder, where maturities are staggered each year, is an excellent way to achieve a decent income stream without assuming a lot of risk. As the shortest maturity bonds come due, the investor simply extends the ladder back out to 5 years with other bond purchases. It’s not an automatic-pilot investment plan, but it does provide for a fairly passive, cost-effective way to invest for income.

Of course owning short-term bonds means you give up the potential high returns from stocks or real estate investments going forward, but you certainly sleep better at night and should do a much better job of preserving your wealth. Furthermore, I’m not sure many investors are aware that bonds beat stock returns over many years in certain cases. Barron’s recently ran an article that showed that for the past two hundred years (that’s not a typo…1802 to 2008), stocks beat bonds by an average of 2.5% annually. But, during the most recent 41-year period, bonds have actually outperformed stocks, and without the crazy volatility associated with stock ownership. Bonds also beat stocks from 1803 to 1871 and again from 1929 to 1949. My point is there are periods of multiple decades when owning stocks is simply not worth the risk of loss and bonds are a better alternative.

Certainly, from present depressed levels, stocks may well outperform bonds going forward and a strong case can be made that present valuations would suggest this to be the case. We just don’t know for sure.

At any rate, if you are a moderate or moderately-conservative investor, or even a somewhat more aggressive investor who wants some balance in your portfolio, you should consider building a short-term corporate bond ladder. Again, there are a lot of attractive offerings, with short maturities, that provide returns above CD rates.

Here is an example of a Short-Term Investment-Grade Corporate Bond Ladder:

Short-term corporate bonds are an excellent vehicle to help investors meet their income needs and maintain their lifestyle during retirement—or even for younger investors who can’t stomach the risks associated with stock ownership. If stocks continue to offer volatile and below-average returns, short-term corporate bonds should remain steady performers and you’ll more than likely be very happy you had a significant portion of your portfolio in this asset class.

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