The Vanguard Total Bond Market Index Fund Can Take the Guesswork out of Bond Investments

By Markets Fool.com

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The Vanguard Total Bond Market Index Fund is designed to give investors broad, diverse exposure to U.S. investment-grade bonds, both government and corporate, of varying maturities. Although bonds are seen as risk-free by many investors, there are some things to take into consideration before investing in the fund.

The Vanguard Total Bond Market Index Fund's portfolio

As the name implies, the Vanguard Total Bond Market Index Fund invests in a broad portfolio of bonds. As of May 31, 2016, the fund held more than 8,000 different bonds and had total net assets of $163.3 billion.

The majority (62.9%) of the fund's bonds are backed by the U.S. government, and the remainder are issued by corporations. All of the bonds in the portfolio are of investment-grade credit quality, with more than 85% having "A" credit ratings or higher.

Maturities are also staggered, in order to further diversify the portfolio:

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Effective maturity

% of fund's investments

Less than one year

1.6%

1-3 years

22.8%

3-5 years

25.1%

5-10 years

33.8%

10-20 years

3.9%

20-30 years

12.3%

More than 30 years

0.5%

Data source: Vanguard.

The average coupon interest rate of the fund's portfolio is 3.2%; however, since interest rates are historically low and many bonds trade for a premium to face value, the average yield to maturity is just 2.2%. Since its inception in 1986, the fund has averaged a total return of 6.23% per year.

As far as expenses go, the fund has a low 0.16% gross expense ratio, which is 80% lower than the peer average, according to Vanguard. The minimum initial investment for either a general brokerage account or IRA is a relatively high $3,000.

It's important to mention that it's also available as an exchange-traded fund -- the Vanguard Total Bond Market ETF .

Risks of investing

Since the fund invests exclusively in investment-grade bonds, the majority of which are backed by the U.S. government, the risk of default is extremely minimal.

Rather, the main risk factor with bonds has to do with interest rates. Specifically, as interest rates rise, the market value of existing bonds can drop, a fact that's especially true with long-dated bonds. While this isn't much of a concern for investors with no plans to sell their holdings (such as retirees), it's still a legitimate concern that the principal value of one's investments could and likely will erode once interest rates begin to normalize.

How to use the fund

This and other bond funds are best used as a supplement to a diverse portfolio of stocks or stock-based mutual funds. Younger investors who have high tolerance for risk and lots of time to let their investments grow should have a minimal allocation to bonds, and this should gradually increase as the target retirement date approaches.

However, bonds shouldn't make up the bulk of any non-retired investor's portfolio, and this is especially true in the current low-interest environment the risk/reward simply doesn't make sense. In order to get a good idea of how to properly allocate your money into stocks and bonds, it's a good idea to check out some of Vanguard's target-date funds to give you a sense of proper allocation for your age.

The bottom line is that while bonds don't pay particularly well right now, and shouldn't make up the bulk of most investors' portfolio, they do have some place in a well-rounded investment strategy. And with its diverse portfolio and low fees, the Vanguard Total Bond Market Index Fund is a great option.

The article The Vanguard Total Bond Market Index Fund Can Take the Guesswork out of Bond Investments originally appeared on Fool.com.

Matthew Frankel has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.