Taxable vs. Tax-Exempt Funds

One last issue to deal with is taxes — unfortunately. Vanguard has a slew of excellent tax-exempt funds, and it's really important to review the tax-equivalent yield information in my monthly newsletter's Performance Review to determine if it makes more sense for you to use a taxable or tax-exempt option.

Just remember that when comparing taxable and tax-exempt funds you should look at funds with comparable maturities (or durations) rather than letting their names guide you. Yes, Intermediate-Term Tax-Exempt can be compared to all the intermediate-term taxable funds, but Short-Term Tax-Exempt is definitely not a substitute for the short-term taxables.

Now, let's get into some of the specifics of Vanguard taxable fixed-income offerings.

Buy: Short-Term Investment-Grade

Short-Term Investment-Grade is my favorite fund at the short end of the yield curve. That said, its descent last fall certainly tested my claims that the fund is an extremely safe option for those looking to boost yield on large cash reserves.

Because the fund doesn't invest in government-backed securities, it took a beating when credit markets seized up. But it's already on the road to recovery and I remain a huge fan. And who can look askance at a yield of 4.58% when the comparable Treasury fund yields just 1.11%?

I use this fund as a higher-yield cash substitute in my Model Portfolios and would recommend it in that role for most any portfolio invested for the long haul.

Of course, because some of the income earned in the government funds is free of state and local taxes, you might come out slightly ahead in those funds if you live in a high-tax state. But if taxes are a big concern you should probably be considering a tax-exempt fund.

NEXT: Buy Short-Term Bond Index