"Prediction is very difficult," observed Nobel physics laureate Niels Bohr, "especially if it's about the future." So it's not surprising that predicting the course of your life is quite a challenge. We are not cookie-cutter people but rather individuals with complex personal and investment needs compounded by life in a multifaceted world that's changing at an accelerating pace.

Predicting the financial future is impossible because the basic questions are too complex to solve with any degree of consistency or certainty. The culture of the financial world is like any other culture. It's about intangible, ambiguous, unstable, and often-contradictory stories that people tell each other as they try to make sense of the actions of the marketplace.

Since we don't know what the future holds for you or for the investment markets, your investment strategy should consist of aligning your investments with your life objectives and financial needs rather than trying to guess what asset class will outperform in the future. The 100 percent bond portfolio makes it possible to execute this investment strategy.

The first step in our process of investment planning is to have you define your life objectives and values that reflect who you are now and the lifestyle that you would like to enjoy in the future. Your age, health, and family situation influence your life objectives and your values. Once you define these, the key question in your investment-planning process is what combination of bonds will best support your objectives and values with the least amount of risk? Note that the key question is not which investments will perform best next year or in the next ten years. No one knows the answer to that question. We advise clients to match their objectives and their values with the investments that have the least amount of risk, rather than trying to find the next "hot" investment area that will double their money in a year or two. That is why we like plain-vanilla bonds.

Your present and future life objectives, values, and financial needs depend on many factors that are specific to you and your family. Looking at some basic categories of goals may help you formulate and define your own life objectives and financial needs. We believe that there are three levels of goals and financial needs:

Divide your portfolio into two categories:

Plain-vanilla bonds are predictable. For example, assume you buy a $100,000 bond that has a coupon rate of 5 percent and comes due in ten years. If you reinvested the coupon interest at the rate of 5 percent, you would have about $163,000 at the end of the ten-year period. To make this calculation on a business or financial calculator do the following:

In addition to providing you with coupon interest semiannually, bonds automatically turn into cash in the amount of their face value at their due dates. The future value of investments other than bonds is indeterminable. They may appreciate a great deal in value or they may decline precipitously. That's why we recommend that you support your financial plan with plain-vanilla bonds. We understand that you may wish to speculate. We just want you to carefully decide how much of your money you will put at risk.

The only way to understand the real value of an investment is to determine its return after you pay your taxes. Uncle Sam and some states will take their share. You can't spend what you pay in taxes. There are a few tax guidelines that you should follow to maximize your after-tax return with respect to bonds.

Determine your marginal tax bracket. You need to know your marginal federal, state, and local income tax brackets. In other words, at what rate do you pay income tax to each of these taxing authorities on the interest income you earn? You can find this out from the relevant tax tables of each taxing authority or from your tax preparer if you have one. The question to ask your tax preparer is, "What is my marginal income tax bracket for interest income?"

Let's simplify this discussion by saying that we define a high federal income tax bracket as 25 percent or higher. In 2006, you reach the 25 percent federal tax bracket if your taxable income exceeds $29,700 if you're single and $61,300 if you're married and file a joint return.

State income taxes. You should consider state and local income taxes very carefully because they vary greatly. Some states such as Florida and Texas have no state income tax and some high-tax states, such as California, have a top state income tax rate that exceeds 9 percent. If you live in a high-tax state like New York and in a high-tax city like New York, your tax bracket may be very high once you combine your federal, state, and local tax brackets.

Before you make an investment, consider the total amount of taxes you would pay. For example, which bonds will give you the highest after-tax returns? You can get a rough idea of the impact of taxes if you compare tax-exempt bond yields to taxable bond yields with the calculator found at www.investinginbonds.com. Or you can use the simple formula found in chapter 19, relating to bond strategies. It makes sense to consider the tax consequences of other nonbond investments as well. However, you should always consult your tax adviser before you invest because the Web site calculator doesn't take into account your particular tax situation, including whether you're subject to the AMT.

If you live in a high-tax state and need a cash-equivalent investment, consider a money market bond fund that holds state-specific bonds. For example, if you live in California, you might invest in a money market fund that holds only California tax-free municipal bonds so that your interest income would be free of federal and California income taxes. However, if you are subject to the AMT, it might be more important to fund a money market fund that doesn't own AMT bonds.

Selection of investment accounts. See Richelson Investment Rule 7: Check for the seller's conflict of interest. Focus on the distinction between the two kinds of accounts available to individual investors: taxable accounts and tax-sheltered retirement accounts. Tax-sheltered retirement accounts include IRAs, 401(k) plans, 403(b) plans, and other pension accounts. For simplicity's sake, we'll refer to all these accounts as pension accounts. The key question is which of your investments should be in a taxable account and which should be in a pension account.

You should keep after-tax investments in your taxable account. The interest income recognized in your taxable account is subject to federal income tax, except for interest income earned from tax-free municipal bonds. That means that if you're in the 25 percent tax bracket or higher, you should consider buying tax-free municipal bonds in your taxable account. If you're in a lower tax bracket, you might consider buying taxable bonds in your taxable account because taxable bonds generally yield more interest income than tax-free municipal bonds of the same rating and maturity, even on an after-tax basis.

All income and capital gains recognized in your pension account each year are tax-deferred and not subject to tax in the current tax year. However, money and securities paid to you from your pension account (except for Roth IRAs) are generally taxed at your ordinary income tax rate in the year they're distributed to you no matter what investments your pension account holds. Therefore, if you generate capital gains in your pension account, you will have converted lightly taxed capital gains into ordinary income when these gains are distributed to you. That's why some tax advisers counsel that you hold your stocks in your taxable account.

If you can get a deduction for a contribution you make to your pension account, you should seriously consider doing so. If an employer will match some or all of your contribution to a 401(k) account, prudence dictates that you should make your contribution and get the financial and tax benefits. Unfortunately, 401(k) plans generally offer a menu of mutual funds and are not self-directed. This means that participants can't buy individual bonds in a company-sponsored 401(k) plan. Our recommendations for a 401(k) plan are as follows: buy bond index funds, money market funds, short-term bond funds, GNMA funds, and high dividend-paying stock funds such as a value stock index fund. If you purchase a fund with dividend-paying stocks and bond funds, you will guarantee a flow of income that can compound. However, there will be no shelter from market fluctuations.

Although deferred-income annuities are often recommended for pension accounts, they should be purchased only in your taxable account because their main selling point is that they provide a tax-deferral. There is no need to pay the costs of an annuity to get a tax deferral when you already get a tax deferral in your pension account. Annuities may be suggested for your retirement account because that may be where your money is, but generally that choice is not in your best interest.

If you invest in U.S. savings bonds, you receive a tax deferral, as discussed in chapter 7. In addition, there are major tax opportunities available for certain taxpayers to fund education expenses with U.S. savings bonds. See the "Special Features" section of chapter 7, relating to U.S. savings bonds.

The purpose of Step 4 is to match bond investments to the three general types of financial needs: emergencies, identifiable needs, and unanticipated transitions.

A cash reserve for emergencies. How much ready cash do you need to set aside for emergencies, such as a job loss or an illness? The traditional advice is that you should have somewhere between three months and one year's worth of readily available cash and cash equivalents to weather these storms. The answer will be specific to you and your family situation and should take into account whether you and/or your spouse have adequate insurance coverage (which you should consider having) in the following areas:

If you take the planning steps set forth below, you may need to keep much less in cash. The calculation should also take into account the probability of finding satisfactory new employment during the next year. There may be other employment opportunities available, but in today's economic climate, finding a job that's the right fit for you might take longer. Therefore, be prepared by considering our recommendation to set up the following lines of credit before an emergency occurs:

If you have a portfolio of bonds or stocks in a brokerage account, you will be able to take a margin loan for personal expenses against the value of your portfolio in your brokerage account. If you are not currently taking a loan against your securities, all your bonds and stocks should be in a so-called cash account at your brokerage firm. That way, in the event of a bankruptcy of your broker or custodian, your securities will be legally more secure.

If you need to borrow against your securities, you can quickly switch some or all your securities from the cash account to a so-called margin account. You can borrow between 50 percent and 90 percent of the value of your securities in your margin account, depending on which securities you hold and the custodian that holds them. Thus, if you have a short-term need for cash, you don't have to sell your bonds to get it. With a margin account loan, the interest rate you pay for the loan generally declines as the amount of the loan increases. Keep in mind that if you need to sell your plain-vanilla bonds, they are very liquid and can be easily sold at a small cost.

As you can see from the number of uncertainties and possible emergencies mentioned earlier, if you have good insurance coverage and good lines of credit, the amount of cash and cash equivalents you need keep on hand to fund emergencies may be very small. If you have a substantial bond ladder, you might have a quantity of bonds coming due each year. In that case, no special planning is necessary, other than to have adequate insurance and good lines of credit.

To the extent that you wish to have cash equivalents to fund any emergencies, they would be among the following:

Funding identifiable needs, objectives, and anticipated transitions. As part of your financial-planning process, you should identify those needs, life objectives, and anticipated transitions that you believe will occur during your lifetime. You would then match these specific items with bonds that come due when you believe you will need the cash. Bonds are perfect for this matching process because you can buy bonds coming due in any year you need the money. All your identifiable needs should be taken into account when you plan your bond ladder.

Suppose you're saving for a custom addition to your house, an expensive vacation trip to Africa in three years, or college in ten years. In these examples, your needs dictate investments in bonds that will come due when you need the cash. For example, the date when money will be needed for college tuition is predictable. You can fund college tuition by buying bonds that come due when your child will be eighteen, nineteen, twenty, and twenty-one. If you are in a high tax bracket, you would buy tax-free municipal bonds to come due in each of the required years rather than taxable bonds.

An excellent choice to fund college tuition for high tax-bracket individuals is deferred-interest, zero-coupon, tax-free municipal bonds because they often pay more interest than coupon municipal bonds. In addition, zero-coupon bonds save you the trouble of reinvesting the interest as it comes due. Another possibility to fund college tuition expenses are EE and I savings bonds. See the discussion in chapter 7 on how to use these bonds to fund education tax free if your income doesn't exceed certain limits.

The ideal bonds to use to fund your identifiable needs and specific objectives would be our old friends the plain-vanilla bonds listed below:

These plain-vanilla bonds provide the ultimate in security. There is little possibility of a default, and market risk is reduced if you create a custom bond ladder. Longer-term, plain-vanilla bonds will not default, but they do have market risk (inflation risk) because of their longer maturities. The longer-term investments we suggest generally provide a higher yield than the shorter-term investments without any more default risk. However, market risk increases if the long-term bonds must be sold before they come due, whether you purchase individual bonds or a bond fund.

Your specific selection of bonds should depend on your tax status. For example, if you are seeking tax-free income, you would concentrate on highly rated tax-exempt municipal bonds. If you are looking to defer tax payments, you would choose series EE and I U.S. savings bonds. If you are in a high tax bracket, you would not want to purchase zero-coupon taxable bonds or TIPS bonds in your taxable account because if you do, you would pay current taxes on imputed interest income and you don't receive the cash until maturity. Zero-coupon bonds and TIPS are excellent choices if they're held in a pension account.

If you live in a high-tax state, you might find Treasuries and certain agency bonds attractive because they are not subject to state and local income tax. (See chapter 8.) If you are concerned that your portfolio may be eroded by inflation, invest in TIPS and I U.S. savings bonds.

Funding unanticipated transitions. When we provide a financial plan for a client, we always consider unanticipated transitions and bumps in the road, such as a critical illness, disability, death of a spouse, divorce, job change, and job loss. Fortunately, many of these adverse events can be covered by insurance. However, having a significant portfolio of plain-vanilla bonds arrayed in a bond ladder provides additional protection against the fallout from these events. For investors concerned about unanticipated transitions, we can't stress enough the protection and peace of mind that a significant portfolio of plain-vanilla bonds provides.

Many investors dream of having financial independence, but most people do not want to make the sacrifices required to achieve it. They seek, at best, to accumulate enough investment assets to deal with the unanticipated transitions and bumps in the road. For those hardy souls who seek financial independence, there is no better solution than the 100 percent bond portfolio producing more interest income than your cost of living. Remember that there are two ways to get to financial independence: generate more interest income, or reduce your expenses. Down-shifting to reduce expenses could put many investors on the road to financial independence.

If you need reliable income as you get older, when you have fewer years to make earned income, you should create a program to save more money. If you have earned income that is high one year and low the next, a stream of income from your bonds that smoothes out your cash flow's ups and downs would be very desirable.

Starting out with less than $25,000 to invest. If you have less than $25,000 to invest, buy short-term or intermediate-term bonds. Don't buy long-term bonds because you can't afford the market risk if you need your funds. You don't need to diversify when you buy the plain-vanilla bonds listed below because they are so safe:

If you invest in bonds early in your life, the income will be able to compound, exponentially multiplying many times in your life.