With all the shenanigans going on with corporate balance sheets and companies going under, how risky are bonds?
Without going into a long-winded explanation of the bond market, different kinds of bonds and such, here are a few things to note about corporate bonds.
First off, the corporate bond market is divided into both "investment-grade" and "non-investment-grade (junk)" bonds. The former are the bonds issued by companies which are judged by the rating agencies as less likely to default. The latter, more likely.
In 2007, junk bonds in the US defaulted at a rate of approximately 1%. In 2008, that rate vaulted to 4%. As of Jan 14, 2009, Moody's is projecting that default rate to reach perhaps as high as 15% in the US. But nobody really knows how high it'll go.
As of mid 2008, the investment-grade bond default rate was approximately 0.13%. Unfortunately, that somewhat belies the risks in investment-grade corporate debt because often that debt is downgraded to junk and only then does it go into default. The risk there is not just default, but downgrades. That said, investment-grade debt is generally quite unlikely to default.
So, with the market behaving as it is, how are investors (lenders) compensated for those risks of default? That risk is reflected in the yield spread between these bonds and bonds which are considered so safe as that their risk of default is basically zero. That is, the risk of those bond defaults (and downgrades) is reflected in the difference between these bonds' yields and the yields of US Treasury bonds. When folks aren't afraid of defaults, those spreads tighten and when folks are afraid of defaults, those spreads widen. Recently, those spreads have been very very wide as investors shun corporate debt and retreat to the (apparent) safety of treasuries.
So where does that leave bonds and how do they still work in a portfolio? It depends on what role the bonds are being purchased to play. Treasuries may be the best way to counter the volatility of a stock portfolio. When stocks are doing great, treasuries may be doing okay, but when stocks are doing very badly, often, treasuries do well - as they have in 2008. However, treasuries are not generally a great way to get income or even low-volatility steady returns from a portfolio. Shorter term investment-grade corporate bonds generally pay a much higher interest rate than treasuries, but because they are shorter term, they have very low volatility. They won't offset stocks the same way, but they will lower a portfolio's overall volatility a lot, and with very little (though certainly some) risk of default.