Here are some basic financial relationships you need to understand when constructing a portfolio of stocks and bonds:

1) Bond prices move in the opposite direction of interest rates. In other words, rising interest rates are generally bad news for bonds; falling rates are good news. Another relationship to understand between bonds and interest rates is that the longer the maturity of the bond, the more sensitive the bond price is to interest-rate movements. Also, the smaller the bond's coupon rate, the more sensitive the bond price is to interest-rate movements. A 20-year zero-coupon bond, for example, is extremely sensitive to interest-rate movements because of the bond's long maturity (20 years) and low coupon rate (zero).

2) Stocks have different correlation of returns. When building a portfolio of stocks, you want to hold stocks that have a low correlation of return relative to one another. For example, you don't want a portfolio of all utility stocks, since utility stocks will behave similarly as a group. Rather, you want stocks that will behave differently. That is the essence of portfolio diversification - owning a basket of stocks that are not closely correlated. One way to build a diversified portfolio of stocks is using beta. Beta refers to how a stock has historically performed relative to the market. A stock that has performed exactly in line with the market during up and down periods has a beta of 1.0. A stock with a beta of 0.5 experiences half the movement of the overall market. Low beta stocks provide a portfolio with some defensive characteristics during market downturns. High beta stocks help juice a portfolio during strong market periods.

3) Understanding the relationship between inflation and stock valuations is critically important. Stock valuations are based on valuing the future stream of a company's cash flows. Inflation is all about the erosion of value over time. Thus, stock valuations (as reflected by price/earnings ratios) generally fall during periods of high or rising inflation and rise during periods of low or declining inflation.

4) For income investments, there is a definite relationship between yield and risk. Think of yield as a proxy for risk. For example, let's say you are considering an electric utility stock that is yielding three percentage points higher than the group average. That high yield is reflecting a higher degree of risk in the stock and the dividend stream. Remember - there are no free lunches on Wall Street. Yields that seem too good to be true usually are. This is especially the case in real estate investment trusts and other similar investments where yields of 11% or more are not uncommon. Don't be taken in by those high yields. Such a high yield often turns out to be short-lived.