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Taxable Bonds: The New Dividend Play |
May 13, 2009 By Dan Wiener, Editor, Independent Adviser for Vanguard Investors |
Dan Wiener
Daniel P. Wiener is America's leading expert on investing in Vanguard mutual funds and is editor of The Independent Adviser for Vanguard Investors, a monthly newsletter that keeps abreast of recent developments at Vanguard. The Adviser is a five-time winner of the Newsletter Publishers Foundation's Editorial Excellence Award.
Also From Dan Wiener
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Buy: Short-Term Bond Index
Short-Term Bond Index tracks the Barclays 1–5 Year Government/Credit Index, which is made up of almost 2,000 investment-grade Treasury, government agency and corporate bonds with maturities of one to five years. So it holds both government and corporate bonds.
The fund, by the way, holds more than 1,000 of these securities as it's required to put at least 80% of assets into bonds that are specifically part of the index. What it doesn't own is GNMAs.
Like Intermediate-Term Bond Index, it has a slightly higher duration than the comparable actively managed funds that Vanguard runs. Here, duration is currently about 2.6 years, at the high end of its historical range. Still, risk remains low, as with all the short-term funds.
I own this fund in my Growth Index Model Portfolio for its low risk and reliable performance. That said, indexing the bond market can be tough, and this fund suffered the ignominy of making a couple of really bad calls in 2002, causing it to substantially lag its bogey. Vanguard says it has fixed the problem, and so far it appears they have. I prefer Short-Term Investment-Grade, but I suspect that over time both funds will track more and more closely.
Sell: Long-Term Treasury
Long-term funds are often tempting because of their higher yields, but they come with a price — higher risk. Right now Long-Term Treasury doesn't even offer such a high yield, and I think risk is huge. Should inflation roar back faster than it has of late, this fund could be hit especially hard.
Generally, the bond market is a wonderfully efficient machine, and every time there's a sniff of inflation in the air, long-term yields go up and prices go down. Lately, with the government buying bonds to boost the economy, Treasurys have held up. But eventually that source of support is going to end.
With a duration of 11.6 years, this fund exposes investors to more than twice the risk of the intermediate-term funds. And the yield pick-up just isn't that attractive. I'd rather stay shorter, and safer, than be sorry.
