Bonds are a great way to hedge yourself against the stock market’s volatility. However, bonds themselves can be volatile. There are various ways to invest in bonds allowing us to diversify our portfolio.
Welcome back to the Investing for Interest 101 series (101, 102, 103), where we discuss building a portfolio of interest-bearing assets. Today, I will discuss bond funds that trade on the stock market.
Because these bond funds trade on the stock market, they are susceptible to the same volatility. However, they may move in different directions than equities (stocks). Let’s look at some different types of bond funds and then decide how to best leverage them.
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Treasury Bond Funds. I talked about US Treasuries in “Treasure for Treasuries.” Many funds invest in Treasuries, and most of them focus on various offerings from the government.
For example, you can find short-term (1-2 years) Treasury bond funds. Some funds invest in 20+ year Treasures (for instance, TLT). My favorite bond fund is Vanguard Long-Term Bond Fund or BLV.
The good part about these bond funds is they can serve as an inverse investment to stocks. However, when the market crashes, they may act similarly. I find that these funds have the most inverse reactions during periods of recovery versus stocks.
The best way to invest is by buying some shares and following them for 6-12 months. You have to learn how these funds act before you commit many resources to them. I have been following BLV for about three years, and it makes a great companion to my favorite index fund VTI.
Corporate Bond Funds. Corporate bonds usually offer slightly higher interest rates than government bonds because you take on more risk.
When you hear the term corporate bonds, we talk about highly-rated debt from highly-rated companies. So, these could be bonds from McDonald’s or Johnson & Johnson.
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I don’t jump into corporate funds too often, so I don’t have much to offer from my experience. You can search “Corporate Bond Funds” in Google and start doing your due diligence.
High-Yield Bonds. High-Yield Bond funds consist of poorly-rated debt from average companies. When credit rating companies publish ratings for debt, they base it on the creditworthiness of the company and the debt they produce.
Say company ABC is struggling in the market, they may get a “below investment grade” rating. Then company ABC offers 20-year bonds with a yield of 5%; then those bonds would receive a rating as well.
Typically, when corporate debt yields above 4-6%, they are considered “junk bonds.” Junk bonds are poor-debt from average (or below average) companies.
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Junk bonds may sound like a terrible investment, but they offer high risk/high rewards in the form of high yield. I love high yields as an income investor, so I invest in junk bonds.
Luckily, someone does all the research and work for me when I invest in a High Yield Bond Fund. My favorite high-yield bond fund is SDPR High Yield Bond Fund or JNK (great ticker symbol).
I consider JNK an amazing dividend ETF, solid investment for income investors, or even dividend growth investing. It usually yields about 4% and can offer some capital appreciation—although I wouldn’t invest for this reason.
Bond Closed-End Funds. Finally, let’s talk about Bond Closed-End Funds. If you thought junk bonds offered high yields, you haven’t seen anything yet.
Bond closed-end funds can offer anywhere from 7-11% yields. The reason they offer such high yields is that they utilize leverage. This means they use debt to increase returns.
Yes, the dividend yields will be high; however, this comes at the price of stability. Prices on Closed-End funds can vary wildly with interest rates. Each fund will react differently to interest rates, so dig into the history of each.
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You have to trust the fund managers. I invest heavily into funds run by PIMCO. The bond funds I use in my income portfolio are PTY, PDI, and PDO. They are similar to one another, with slight differences. Be careful when investing in CEFs.
How to use bond funds. You can use bond funds across all three types of dividend strategies—index funds investing, dividend growth, and income investing.
- Index fund investing lines up directly with Treasury Bond Funds. You can match VTI with BLV and have a good balance of growth and hedging. In fact, I like dollar-cost averaging into these two ETFs at a 2 (VTI) to 1 (BLV) ratio.
- Dividend Growth Investing lines up with Corporate debt and junk bonds. Investing in companies like McDonald’s is excellent for the long run. However, you can also add a nice 4% boost via JNK.
- Income investing correlates directly with Bond CEFs such as PTY, PDI, and PDO. I invest in all of these in my various income portfolios. Your risk tolerance may vary, but income investing can be very fun and lucrative if you understand how to invest in CEFs, BDCs, and Mortgage REITs.
Conclusion. Bond funds offer something for everyone. Please ensure you read the investment strategy of each fund. You need to understand how they react to market pressures such as interest rates, inflation, and commodities.
I buy debt across all different classes through these bond funds. They are a great way to diversify from purely investing in companies. Companies, even blue-chips, can have bad years or even fail without notice.
Bond funds can give you a little more security because they consist of 100s and 1000s of companies and bonds. Perform your due diligence on sites like Seeking Alpha and Yahoo Finance. Good Luck!
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Disclosure: I am not a financial advisor or money manager, and any knowledge is given as guidance and not direct actionable investment advice. I am an Amazon Affiliate. Please research any investment vehicles that are being considered. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. All Right Reserved Military Family Investing
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