Vanguard Bond Funds: A Smart Way to Reduce Your Dependence on Stocks

By Matthew

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Vanguard bond, or fixed income, mutual funds can be a smart way to get exposure to fixed-income securities without having to choose individual bonds. Investors can choose from a variety of funds, from the highly diversified Vanguard Total Bond Market Index Fund (NASDAQMUTFUND: VBMFX) to many specialized choices.

Why invest in bond funds?

Bonds are a good thing to have in any portfolio, as they tend to be less volatile than stocks, and therefore can help preserve your capital in a market correction or crash. As a general rule of thumb, younger investors should keep a small percentage of their portfolio in bonds to take advantage of the high-growth potential of stocks, while older investors who don't have the time and tolerance to ride out market volatility should keep a higher percentage of bonds. For a more thorough introduction to asset allocation strategy, check out this article.

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For the vast majority of investors, bond funds are the way to go. Buying individual bonds has several potential drawbacks -- lack of diversification, low liquidity, and the need to invest in $1,000 increments, to name a few. In a nutshell, investing in bond funds gives you exposure to the relative safety of bonds without the challenge and disadvantages of buying individual bonds.

This list includes Vanguard's bond funds that are available in investor shares. Some may be available in Admiral Shares, which have lower expense ratios but higher minimum investment requirements. And some may be available as ETFs.

Vanguard's agency/Treasury bond funds

These funds invest in government bonds as well as corporate bonds of varying mixes and maturities. Just to be clear on some of the terminology here, a "short-term" bond fund invests in bonds maturing in one to five years, "intermediate-term" bond funds invest in bonds with five to 10-year maturities, and "long-term" bond funds invest in bonds with maturities of more than 10 years.

Source: Vanguard

Vanguard's investment-grade bond funds

These funds invest in high-quality corporate bonds, as well as some government securities. Corporate bonds tend to pay more than Treasuries, but can also be slightly riskier. By definition, investment-grade corporate bonds are issued by companies with minimal risk of default, but it's still a possibility.

Data source: Vanguard. The Core Bond Fund hasn't been in existence for a full year, so no TTM yield is available.

If you are a little more adventurous...

Corporate bonds issued by companies with credit ratings below investment-grade tend to pay significantly higher yields, since the probability of default is higher. Vanguard's High-Yield Corporate Fund invests in bonds in the higher-range of below-investment-grade ratings, so we're not talking about companies on the brink of bankruptcy or anything like that. Just be aware that you should expect a little more volatility from these funds.

Data source: Vanguard.

Vanguard's tax-exempt bond funds

These funds are for investors who want federally tax-exempt income, as well as state tax-exempt income from bonds issued by their home state. For example, the Vanguard Massachusetts Tax-Exempt Fund provides income exempt from both federal and Massachusetts state taxes.

Data source: Vanguard. The Vanguard Tax-Exempt Index Fund doesn't have a year's worth of data at the time of this writing in order to calculate TTM yield.

Which are the best for you?

There's no one-size-fits-all answer to that question, but the best advice is to consider your own life situation and investment goals. For example, if you're younger and can withstand a little more risk, you may want to allocate your money to high-yield corporate bonds. If you are worried about inflation eroding your purchasing power, one of the inflation-protected bond funds could be a smart choice. And, if you're in a high tax bracket, it could be to your advantage to consider some of the tax-exempt bond funds.

The bottom line is that within the collection of low-cost bond funds listed here, you can get bond exposure that's tailor-made for your personal investment strategy.

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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.