In the fixed-income market, experienced and novice investors alike can benefit from a refresher. Here's a reminder: When investing in bonds, the two primary forms of risk to consider are credit and interest rate risk.
Even with mountains of debt, the U.S. carries some of the highest sovereign credit ratings in the world, so income investors considering exchange-traded funds (ETFs) such as the Vanguard Long-Term Treasury ETF (NASDAQ: VGLT) don't worry much about credit issues. But with long-term bonds, interest rates are paramount.
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When it comes to corporate bonds and funds such as the Vanguard Long-Term Corporate Bond ETF (NASDAQ: VCLT), end users must consider both credit and rate risk. After all, some issuers default, leaving bondholders with pennies on the dollar, if that.
With that said, let's look at two of the giants of the Vanguard bond stable to pin down which one might merit a place in your portfolio.
For investors seeking extra income, corporate bonds are a fine asset class to consider. The $8.4 billion Vanguard Long-Term Corporate Bond ETF embodies that spirit, as evidenced by its 30-day SEC yield of nearly 6%.
That's high, given that approximately 56% of this ETF's 2,778 holdings are rated AA or A, confirming it is an investment-grade ETF. As such, credit risk is somewhat subdued. The yield and the stout credit sound pretty good, but smart investors are probably wondering what the "but" is with this ETF. It's simple and revealed in its name: This is a long-duration ETF.
The average duration for this ETF's holdings is 12.2 years. For the sake of simplicity, let's call it 12 years. This means that in a hypothetical scenario in which the Federal Reserve raises interest rates by 1% over a series of meetings with no reductions to offset those hikes, a bond (or this ETF) with a duration of 12 years loses 12% of its value.
That's not a knock on this corporate bond ETF, but it is a statement of obvious risk. Consider this fund and others like it as reminders that there are no free lunches in investing. Meaning 6% yields aren't given away without investors accepting some risk. In this case, it's rate risk.
In addition to the tempting yield, this ETF has some high points, including a deep bench of holdings and an annual fee of just 0.03%, making it one of the cheapest bond ETFs of any stripe.
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