Sometimes conservative investors, those who feel right at home investing in CDs, money-market funds and bond funds, seem to get no respect. Some of them shake their heads in wonder at the popularity of aggressive equity investments that can bring hefty short-term returns, along with gut-wrenching volatility.

But after a recent question from an investor whose orientation is fixed-income investing, I have thought newly about retirement portfolio options for conservative investors. Essentially, I held up some of the work we’ve been doing for equity investors and looked at it in a new way. And I was fascinated by what I found.

In one of our favorite articles, "The best retirement portfolio we know," we show how to maximize growth and income in retirement. The article explained some excellent ways to use our worldwide balanced portfolio recommendations to provide retirement income that won’t ever run out. (The worldwide balanced portfolios call for investing 25 percent each in U.S. equities, international equities, U.S. bonds and international bonds.)

Recently, a prospective client called my office, intrigued with the Worldwide Balanced Portfolio, but said it still seemed too risky for him. This investor is extremely risk-averse. He’s contemplating investing in bond funds. For him, that would be an aggressive step away from the comfortable safety of money-market funds and certificates of deposit. With that orientation, it’s easy to see how he could regard equities as very risky.

After our conversation, I began taking a fresh look at a range of fixed-income options, asking myself how Treasury bills, short-term bond funds and long-term bond funds all compare with each other in terms of risks and returns. My objective was to identify the steps up the risk/reward ladder that an investor would take going from CDs to a Worldwide Balanced Portfolio.

I wondered which of those steps is worth taking and what the tradeoffs are for taking each step. In a nutshell, here’s what I found: As you would expect, the general principle holds up that as you seek higher returns you encounter greater risks and uncertainty. This is the eternal investing tradeoff, and it requires thoughtful choices.

However, if you look carefully you’ll see there are a few "sweet spots" along the curve that provide significant extra return for minimal extra risk (or sometimes even at reduced risk). If you’re willing to trust equities when they are widely diversified and carefully controlled, you may find a combination that gives you more of what you want and less of what you don’t want.

Let’s start at the conservative end of the investment spectrum and focus on three-month Treasury bills. These are guaranteed, and as safe as you can get. They don't offer much protection against inflation, of course. But they require you to tie up money for only 90 days at a time.

Since 1926, T-bills have yielded a compound rate of return (CRR) of 3.8 percent. After inflation that works out to 0.5 percent. However, the full 3.8 percent is taxable. Even at the lowest tax bracket, 15 percent, that pushes the real after-inflation return of T-bills into the red.

You won’t ever make much money investing in T-bills. But you’ll never take a loss, either. If safety of your principal is paramount over every other consideration, T-bills might be the right place for your money.

In the study that we show later in this article, we found that T-bills had a compound rate of return of 5.6 percent, when compounded quarterly from the start of 1987 through the 2000. (All return figures in this article and the accompanying table assume the reinvestment of interest, dividends and capital gains.)

That return beats inflation, but not substantially. So I asked myself what would happen to our conservative investor who was willing to take a small amount of risk and migrate up to short-term bond funds, represented in our study by the Vanguard Short-Term Corporate Bond Fund.

The 1987-2000 CRR for this fund was 7.2 percent, a substantial jump from the T-bill return of 5.6 percent. Of the 56 quarters in our study, this fund had six losing quarters (vs. none in T-bills). But the average loss of those quarters was a mere 0.3 percent, and the worst consecutive four quarters was a loss of 0.1 percent.

This leads to the first decision point: Does it make sense for a T-bill investor to migrate up to short-term bonds? I think the answer is yes. For an extra 1.6 percent of annual return, the investor had to endure an annual loss of 0.1 percent during this nearly 14-year period. Think of it this way: If you started with $100,000, you picked up an extra $3,475 every year, on average, In return for that, you experienced a four-quarter period in which you lost less than $200. And that happened only once. The loss is not significant. But the gains are substantial.

Over this period, ignoring inflation and taxes, and with all interest and dividends reinvested, $100,000 in 90-day T-bills grew to $214,435. In the Vanguard short-term bond fund, it grew to $264,684. The difference, about $50,000, was the reward for taking on a little bit of extra risk.

For the next migratory step, I chose Vanguard’s long-term corporate bond fund. Its CRR over this period was 8.7 percent, or another 1.5 percentage point annual increase as we step up the ladder. But along the way, there were 15 losing quarters, including a four-quarter period in which your fund was down 7.1 percent. In my opinion, that makes this fund, all by itself, too risky for most bond investors.

However, the fund’s asset quality is high. In the end, investors in this fund received a premium for the risk they took. Yet the risks were real. Some investors may have become discouraged at the end of the third quarter of 1987, having just experienced back-to-back losses of 3.6 percent and 5.8 percent. If those investors bailed out of the strategy at that point, they would have lost 6.8 percent of their money in just three quarters. That’s a notable loss for conservative investors, and those who bailed out could not participate in the two immediately following quarters, when this fund rose 7.6 percent and 4.1 percent, respectively.

Over this 56-quarter period, an investment of $100,000 in the Vanguard long-term bond fund grew to $321,524. That’s $107,000 more than the final result of an investment in T-bills and $57,000 more than what you’d have in the short-term bond fund. It’s up to you to decide whether or not the extra money is worth putting up with 15 losing quarters and an interim loss of 7.1 percent over four quarters.

The next step is a big one: having half your money in stocks and half in bonds, represented by the column labeled "Buy and Hold" in the table. This is a worldwide balanced portfolio without timing, with 25 percent each in U.S. equities, international equities, U.S. bonds and international bonds.

A 50 percent stock portfolio may be more than many bond-oriented investors are even willing to consider. And in fact it’s a big leap. But consider the results compared with those of the Vanguard long-term bond fund. The return of this 50-50 option is 10.4 percent, up nicely from the 8.7 percent of the long-term bond fund.

On the other hand, if you compare the risk factors at the bottom of the long-term bond and buy-and-hold columns in the table, you’ll see that the 50-50 combination had a higher standard deviation, a higher average loss and a higher loss in its worst four quarters. (I think investors in this 50-50 strategy should be prepared for a worst 12-month loss of 15 to 20 percent.)

However, over 56 quarters, $100,000 invested in the buy-and-hold portfolio grew to $399,546, or $78,000 more than in the long-term bond fund.

For many conservative investors, the extra return of the buy-and-hold portfolio just isn’t worth those extra risks and losses. But for investors who like higher return and lower risk, there’s another alternative that delivers: a worldwide balanced portfolio with all assets subject to market timing.

Now this is an option that’s worth getting excited about as an alternative to the long-term bond fund. As you’ll see in the column of the table titled "Market Timing," this delivered compound annual returns of 11.6 percent, dramatically higher than those of the long-term bond fund. The timing strategy turned $100,000 into $464,835. And at the same time, every risk factor was equal or more favorable.

Compared with the long-term bond fund, a worldwide balanced portfolio with timing had the same standard deviation, 11 losing quarters instead of 15, lower average quarterly losses, and a worst-four-quarters loss of less than 4 percent, vs. 7.1 percent for the long-term bond fund. (But investors should be prepared for one-year losses of 6 to 8 percent with the timed worldwide balanced portfolio.)

For investors interested in maximizing returns and minimizing losses, this is truly a sweet spot. Why was it so effective? Partly because of the defensive strategy of market-timing. Over this period, timing was very effective with bond funds, while allowing investors to capture much of the benefit of the 1990s bull market in stocks.

This strategy requires investors to trust market timing, which is sometimes easier said than done. As you can see in the table by comparing the buy-and-hold and market-timing columns, market-timing results often look quite different from those of buy-and-hold. There are 15 quarters where the difference between the two is two percentage points or more. (Timing underperformed in eight of those quarters and outperformed in seven.)

Besides the higher return, I think conservative investors should like the market-timing strategy because it actively manages market risk every day the market is open. Buy-and-hold, on the other hand, does nothing to manage market risk.

Dyed-in-the-wool bond investors may still be unwilling to commit 50 percent of their portfolios to equities. I’d like them to consider the following comparisons and ask themselves if they’d be willing to undertake what I’ll call for the moment "Strategy X." The results are for the same 56-quarter period, 1987 through 2000.

In my view, that’s a win-win comparison. And what if I told you that "Strategy X" involves having two-thirds of your portfolio in bond funds and leaves two-thirds of your portfolio invested on a buy-and-hold basis, without timing? For conservative investors who don’t fully trust market timing, this may be the best "sweet spot" of all. Its annual return of 10.7 percent would have turned $100,000 into $389,531 over the period under study.

"Strategy X," I can now reveal, is a simple three-way combination of equal parts of the Vanguard Long-term Bond Fund two worldwide balanced portfolios, one with timing and one without timing.

Investors have a wide range of choices, and they can move up the scale in small or large steps to suit their needs. But among the options we have illustrated here, three stand out to me as being particularly worthwhile.

Thoughtful investors will have to ask themselves if the most recent 14 years, on which this study is based, is a representative period. It was a generally good time for U.S. stocks and for all bonds, which got a one-time boost from falling interest rates over most of the period. International stocks, by contrast, were laggards.

You can be sure that future returns will be different from those shown here. But it’s very likely that the relative positions of these strategies will remain the same over the next 14 years and longer periods. Long-term bonds will outperform short-term bonds, and the worldwide balanced portfolios will outperform long-term bonds. And I’m quite confident that conservative investors who combine these strategies in intelligent ways, for instance with the three-way combo we have described, will be well rewarded.