Diversifying Your Portfolio with Fixed Income ETFs

Fixed income investments have long been a popular way for investors to diversify their portfolios and reduce risk. Exchange-traded funds (ETFs) provide an easy way to invest in a variety of fixed income assets, including government bonds, corporate bonds, and international bonds. In this article, we will provide an overview of these types of fixed income ETFs and how they can help you diversify your portfolio.

Government bonds are issued by governments around the world to finance their activities or debt. Government bonds are generally considered to be a safe, low-risk investment. Government bond ETFs provide investors with exposure to government bonds in a single, low-cost package. These ETFs may be composed of bonds issued by a single country, such as US Treasuries, or they may be composed of bonds issued by multiple countries.

Corporate bonds are issued by companies to finance their operations or debt. Corporate bonds tend to offer higher yields than government bonds, but they also come with higher risk. Corporate bond ETFs provide investors with exposure to a variety of corporate bonds in one simple package. These ETFs may be composed of bonds from a single country or from multiple countries.

International bonds are issued by companies and governments outside of the United States. These bonds offer investors the potential for higher yields than US bonds, but also come with higher risk. International bond ETFs provide investors with exposure to a variety of international bonds in one simple package. These ETFs may be composed of bonds from a single country or from multiple countries.

How Do Bond ETFs Work?

Bond ETFs are both actively and passively managed. Passive management keeps their cost very low, much lower than mutual funds or active funds.  Bond ETFs are more liquid than individual bonds, meaning they can be traded more easily and quickly. The ETFs are composed of a basket of bonds with varying maturities, credit ratings, and yields. When you buy a bond ETF, you are essentially purchasing a portfolio of bonds that follow the index. Unlike individual bonds, bond ETFs have no maturity date. The bonds within the ETF will mature, but the money obtained is simply reinvested in new bonds.

Pros and Cons of Investing in Bond ETFs

Pros

One of the primary benefits of investing in bond ETFs is that they are cost-efficient and often have lower expense ratios than traditional mutual funds. This makes them a more affordable option for investors. Additionally, bond ETFs offer diversification and flexibility. They can provide access to multiple bonds, such as government bonds, corporate bonds, and international bonds, in a single fund. This helps to reduce portfolio risk by spreading out the exposure to different types of bonds.

Another advantage of investing in bond ETFs is that they can be traded on an exchange, like stocks. This provides investors with the ability to buy and sell the fund quickly and easily. As a result, investors have the ability to move in and out of the fund quickly and react to market conditions.

Cons

While there are many advantages to investing in bond ETFs, there are also some drawbacks to consider. One of the primary drawbacks is that the bonds held within the ETF may have different maturity dates, which can make it difficult to control the timing of your cash flows. Additionally, bond ETFs tend to have higher interest rate risk than individual bonds, as the rate of return of the ETF is affected by the underlying bonds.

Bond Funds to Consider

iShares Core U.S. Aggregate Bond ETF (AGG), Vanguard Total Bond Market ETF (BND), and Vanguard Intermediate-Term Corporate Bond ETF (VCIT) are three of the more popular bond ETFs and offer a variety of advantages to investors.

iShares Core U.S. Aggregate Bond ETF (AGG)

Investing in AGG provides exposure to the U.S. investment-grade bond market, with the ETF’s portfolio composed of U.S. Treasuries, government-related and corporate bonds, mortgage-backed securities, and asset-backed securities. AGG is a passively managed fund, which means that costs and expenses are kept low, making it an attractive option for investors who wish to passively invest in the bond market. Additionally, AGG offers diversification by providing exposure to a broad range of bonds, which can help investors reduce their overall risk.

Vanguard Total Bond Market ETF (BND)

BND is another popular ETF that tracks the performance of the entire U.S. investment-grade bond market. Like AGG, BND is a passively managed fund and offers a low-cost option for investors who wish to diversify their portfolios with exposure to the bond market. BND’s portfolio is composed of U.S. Treasuries, government-related and corporate bonds, mortgage-backed securities, and asset-backed securities. Additionally, BND offers broad diversification and exposure to a wide range of bonds, which can help investors reduce their overall risk.

Vanguard Intermediate-Term Corporate Bond ETF (VCIT)

VCIT is an ETF that tracks the performance of the intermediate-term corporate bond market. VCIT’s portfolio is composed of corporate bonds with maturities between four and ten years, making it an attractive option for investors looking for higher returns than what AGG and BND offer. Additionally, VCIT offers diversification by providing exposure to a wide range of intermediate-term corporate bonds, which can help investors reduce their overall risk.

By investing in a variety of fixed income ETFs, investors can diversify their portfolios and gain exposure to many different types of bonds. This diversification can help reduce risk while still allowing investors to benefit from the higher yields offered by some of these bonds. Fixed income ETFs can also provide investors with access to bonds that they may not otherwise be able to access on their own.