Bond funds come in all types and risk levels

What they are

How they work

Like equity mutual funds, bond funds can be narrowly focused on high-quality, safe investments or they can be all over the map, pulling in bonds from emerging markets, asset-backed securities, high-yield and investment-grade corporate bonds.

Advantages and disadvantages

Warning

For the past 30 years, bonds have enjoyed a great run, but experts predict that a change may be on the horizon.

"I'm avoiding anything with a government guarantee because the central bank is buying that debt and artificially pushing those (yields) down," says Larkin.

The yields are too low on mortgage-backed securities, U.S. agencies and U.S. Treasuries. In a 5 percent inflation environment, things could change very abruptly, and some of the losses could be quite substantial, he says.

For investors who cannot risk losing any principal, Larkin suggests earning close to zero is preferable to investing in bond funds.

"The risks are rising that the change might be coming," he says.

Considerations

For a small portion of their fixed-income portfolio, investors may want to consider bond funds with an unrestrained strategy -- they typically fall into the Morningstar category of multisector bond funds. These funds go further afield than a traditional bond fund, picking up currencies and derivatives such as futures contracts and swap agreements. Plus they hold bonds of varying credit quality from corporations in the U.S., foreign countries and emerging markets.

"They can go do whatever they want. So you're letting someone very, very skilled at the markets go and find the best value," says Larkin.

Using one of these funds for a piece of your portfolio could add some diversity and let professionals do the legwork.