Financial headlines touting the existing "bond bubble," the eventual bond "crash," and the death of safe US Treasuries, as we now know them run rampant.

The reason: the government's overall increase in spending over the last two years plus the massive printing of dollars in 2008 and again this year may breed inflation in the coming years.  With higher inflation, the price of a given bond goes down. 

Many dentists, including myself, have parked a good proportion of our portfolios into bonds and bond funds over the years.  In fact, I was able to retire early due to investing in muni bonds over the years, not stocks as many would think.  Does it make sense to bail out of bonds?  And if so, when?

Below is a quick paraphrase of an article written by Larry Katz, CFA, MBA, which can be read in full at www.fundadvice.com/articles/investing-basics/inflation-bonds-6.16.10.html.

Katz writes of economist's and academic's expectations for the next ten years according to the Livingston Survey, a survey dentists rarely hear about amongst the drivel of all the Wall Street fear-mongers.   In short, inflation for 2010 is projected to be 1.8% and 1.7% in 2011.  The ten year projection, out to mid-2020, is 2.3%.  No one knows if inflation will increase in coming years, yet would you rather follow Wall Street hawks like Jim Cramer or the nerds that really understand M1, M2, and quantitative easing? 

Katz, and almost all the academic-based investment advisers, feel a significant portion of one's portfolio should always be invested in bond funds.  The 60/40 mix of stock funds to bond funds has stood the test of time, especially over the past ten years.

He posits that for bonds, an inflation-protected structure is in order, just in case we revisit the 1970's. 

For a tax-deferred account, Katz suggests 20% of one's bond holdings in TIPS, 30% in Short-Term Treasuries, and 50% in an Intermediate-Term Fund.1  For one's entire portfolio with a 60/40 mix, this would become 8% TIPS, 12% ST Treasuries, and 20% IT Funds.

For after-tax accounts, he suggests 15% in an Intermediate-Term Fund1, 40% in a Limited-Term Tax-Exempt Fund, and 45% in an Intermediate-Term Tax-Exempt Fund.

Note, no long-term funds are included, as they would be hardest hit with rising inflation.

As an afterthought, Katz raises the specter of deflation.  This one is scary, docs.  Deflation would keep people from buying products, as they would wait for prices to lower.  Delayed consumption would increase unemployment and potentially hurt stock prices.

The chances of near-term deflation appear to be higher than inflation, in my opinion.

High-yield, corporate, and non-government issues have much more volatility than government funds and it may be wise to avoid, as principal amounts could crater with higher inflation.

Bottom line:  Think carefully before ditching government bonds and bond funds.  They worked to bail many of us out in the last decade.  A 60/40 diversified portfolio rose 4% per year in the "lost decade."