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How Can You Get the Most from Your Bond Investments?

How Can You Get the Most from Your Bond Investments?
By Ron DeLegge, Editor
August 26, 2009

SAN DIEGO (ETFguide.com) – “Gentlemen prefer bonds,” was an expression made famous by wealthy financier and former Secretary of the U.S. Treasury, Andrew Mellon. It was Mellon’s view that putting money into tax free bonds was the best way to avoid getting skinned by the tax man.

Fast forward to today.

These are trying times for bond investors. Interest rates are still stuck at record low levels which means lower income generated from bonds and other fixed income investments.

U.S. Treasuries with a 10-year maturity are yielding just 3.50%, which isn’t much over the lifetime of the investment, especially after deducting the cost of taxes and any potential for re-inflation. The interest rates being paid by bank certificates of deposit (CDs) is also down. According to BankRate.com, today’s national average 5-year rate for bank CDs is just 2.65%.

What can bond investors do?

Let’s briefly evaluate 5 bond ETFs that can help you to generate more income from your bond investments.

iShares Barclays Aggregate Bond Index Fund (NYSEArca: AGG)
The performance and yield of AGG are linked to the widely followed Barclays U.S. Aggregate Bond Index. The index measures the U.S. investment grade bond market, which includes investment grade U.S. Government bonds, investment grade corporate bonds, mortgage pass-through securities and asset-backed securities. With almost $10 billion in assets, AGG is the largest bond ETF and it carries a yield in the vicinity of 4.5%.

Year-to-date, AGG has declined 1.2%. In 2008, AGG gained 5.88% and the fund’s annual expense ratio is 0.24%. 

iShares iBoxx $ High Yield Corporate Bond Fund (NYSEArca: HYG)
HYG is benchmarked to the iBoxx $ Liquid High Yield Index, which is designed to provide a balanced representation of the U.S. dollar-denominated high yield corporate bond market through some of the most liquid high yield corporate bonds available. The number of bond issues within HYG is typically 50, although this may change from time to time. The fund has close to $2.13 billion in assets and carries a juicy yield of 11.56%.

Year-to-date, HYG has increased by 16.29%. In 2008, HYG fallen 23.86% and the fund’s annual expense ratio is 0.50%. 

iShares MBS Bond Fund (NYSEArca: MBB)
Over the past 5-years, a disappointing 100% of all actively managed mortgage-backed securities mutual funds have underperformed the Barclays U.S. MBS Index, which MBB follows. MBB’s underlying index measures the performance of investment grade mortgage-backed pass-through securities of GNMA, FNMA and FHLMC. The index includes fixed-rate mortgage pass-through securities issued by GNMA, FHLMC, and FNMA that have 30-, 20-, 15-year and balloon maturities as well as hybrid ARMs mortgage pass-through securities.

Even in the face of a storm in the mortgage securities business, in 2008, MBB rose 7.34%. The fund’s yield hovers around 4.2% and its annual expense ratio is 0.35%. 

SPDR Barclays Capital TIPS (NYSEArca: IPE)
IPE is benchmarked to the Barclays U.S. Government Inflation-linked Bond Index, which measures the performance of the inflation protected public obligations of the U.S. Treasury. Inflation protected securities are commonly known as just “TIPS.” These are securities issued by the U.S. Treasury that are designed to provide inflation protection to investors. IPE’s yield hovers around 5.4%.

Year-to-date, IPE has risen 6.24%. In 2008, IPE fell 2.33% and the fund’s annual expense ratio is 0.18%. 

Vanguard Intermediate Term Bond ETF (NYSEArca: BIV)
BIV follows the Barclays Capital U.S. 5-10 Year Government/Credit Index. The Index includes U.S. Treasury and agency obligations, as well as investment-grade (rated Baa3 or above by Moody's) corporate and international dollar-denominated bonds, all having maturities of 5 to 10 years. BIV’s yield is 4.7%.

Year-to-date, BIV has fallen 1.40%. In 2008, BIV increased by 5.06% and the fund’s annual expense ratio is 0.11%. 

Getting Exposure to Bonds
Bonds, like stocks, come in many different varieties. Government bonds are issued by U.S. or foreign governments, municipal bonds are issued by cities, states and local governments, corporate bonds are issued by companies and there are also asset-backed securities, mortgage backed securities and convertible bonds. Treasury Inflation Protected Securities (TIPS) allow you to hedge against the possibility of future inflation.

Getting exposure to all of these bond sectors with individual bonds can be time consuming and costly. On the other hand, diversifying your bond portfolio with bond ETFs helps you to avoid taking too much risk on individual bonds. 

Your Income Strategy
“People have the tendency to own the wrong bonds in the wrong amounts and for the wrong reasons,” says Russell Wild, MBA and author of Bond Investing for Dummies (2007 Wiley). According to Wild, some people own too few bonds, making their portfolios unintentionally more volatile whereas others may own tax-free bonds when they should really own taxable bonds. He adds, “Others are so far out of the limb with shaky bonds, that they may as well be lending money to Tommy Potts.”

Bond ETFs can help you to diversify the duration and credit risk from your bond investments. Another benefit of bond ETFs is the rock bottom fees compared to actively managed bond funds, which in many cases are twice as expensive to own. Keeping your investment fees is low is one key to getting more income from your bond investments.

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