Investing in bonds is a simple way to add diversification to your portfolio and reduce your risk. That includes corporate bonds for your money market account, bond funds, government bonds and municipal bonds. My bedrock investing strategy is to follow the 60-30-10 rule — You want 60% in fixed income, 30% in general equities, and 10% in gold and foreign currencies. Fixed-income securities include treasuries, investment-grade prefereds, corporate bonds, and AAA tax-free municipals.

If you’re a bit more aggressive you can reduce the amount you put into bonds. But make no mistake, bonds should be part of every investor’s portfolio.

But what bonds should you be buying? Well, for now I recommend with short-maturity bonds on the fixed-income side of your portfolio. Here’s why:

Chart A is a long-term chart of the 10-year Treasury yield. Long Treasuries ended a 30-plus-year secular bull market in December of 2008 at the height of the credit crisis. We are now just beginning what could be a multidecade bear market in long bonds. Two of the biggest risks to higher rates in the medium term are the Federal Reserve’s excessive balance sheet and the inordinate amount of government debt issuance.

Chart B shows excess reserves in the banking system. There are over a trillion dollars of excess reserves that banks could decide to multiply 10 times over. Mr. Bernanke has convinced himself that the Fed can successfully manage its balance sheet without causing 1) an explosion in money supply or 2) much higher interest rates. I remain cautious. We are operating in unprecedented territory. There is significant risk here, and all prudent investors must consider the damaging consequences of a misstep.

Chart C shows that the Congressional Budget Office projects massive U.S. budget deficits for the foreseeable future. The U.S. simply cannot afford to continue running massive budget deficits without risking a future debt debacle or anemic economic growth.

Chart D shows total U.S. government debt held by the public relative to GDP and CBO projections for these figures out to 2020. Debt is projected to increase to 90% of GDP over the next 10 years from 44% when President Obama took office. Is this the change Americans voted for? The U.S. has enough accumulated wealth to finance this debt explosion for a period of time, but it will only be financed at much higher interest rates and by crowding out private investment.

The risks of investing in long-term bonds far outweigh the meager rewards being offered today. Keep your maturities short when buying bonds.

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