Do you need bonds in your portfolio?
The question is, of course, a personal one. Those with goals in the three- to 10-year range--say, buying a new home, retiring within the next decade, or sending your youngest who just started high school to college--likely do. Bonds are also favored by investors who may not be comfortable being 100% in equities, no matter their time horizons.
Exchange-traded funds focused on fixed-income securities can be excellent choices for getting exposure to bonds. For starters, many ETFs are transparent--they track indexes with very specific duration and credit-quality traits--and offer few surprises. Moreover, they're usually low-cost, which is even more important when investing in bonds than in equities: Every basis point paid in expenses is one less basis point in return, and returns are typically tougher to come by with bonds than with stocks.
A good place to start your search for top bond ETFs is with the Morningstar Analyst Rating. Funds that earn our highest rating--Gold--are those that we think are most likely to outperform over a full market cycle.
The funds span a variety of fixed-income categories. However, when it comes to bond investing, intermediate-term funds are the starting point--and for many, the ending point, too.
"Be sure to start building your bond-fund portfolio with core, intermediate-term funds that give you a lot of diversification in a single holding," recommends Morningstar director of personal finance Christine Benz.
Morningstar divides intermediate-term bond funds into two separate categories: intermediate core bond and intermediate core-plus bond. Funds in both Morningstar Categories invest largely in investment-grade U.S. fixed-income issues, including government, corporate, and securitized debt; they usually maintain durations that range from 75% to 125% of the three-year average effective duration of the Morningstar Core Bond Index. The difference: Core-plus funds have more flexibility to own noncore bonds, such as corporate high-yield, bank-loan, and emerging-markets debt. As a result, they may boast higher yields than their core bond counterparts, but core-plus funds generally don't offer the same diversification benefit to a stock-heavy portfolio.
Dig deeper: For Bond Funds, Is Core-Plus Really a Minus?
Should your search for a bond ETF stop with intermediate-term funds? Not necessarily. Perhaps your goals are nearer-term in nature. In that case, funds from the short and ultrashort categories might be a better fit for you.
Watch: What Type of Bond Funds Do You Need
Further, the funds landing in the inflation-protected bond category might be suitable for those looking to add a bit of inflation protection to their portfolios--especially to a bond-heavy portfolio. Treasury Inflation-Protected Securities funds are especially good choices for those in retirement, says Benz.
"The part of your portfolio that you're withdrawing from for your living expenses--that's not getting inflation-adjusted because it's often in bonds," she says.
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