Simple Ways to Win With Bonds

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Most investors realize that they need more than stocks in their investment portfolios in order to reach their financial goals successfully. Many turn to bonds for diversification.

But if you think it's tough doing research on the thousands of different stocks you can buy, wait until you dive into the even greater complexities of the bond market. Most companies only offer one class of stock, but you can often find several different bonds from any given issuer. And even once you pinpoint the right one, buying individual bonds can be a lot harder than buying a stock from your discount broker. But you can find some simpler ways to invest in bonds, without learning the ins and outs of an entire new mode of investing.

Buying bonds through ETFs
All this week, I've taken a look at how investors can invest in various assets using exchange-traded funds, including domestic and foreign stocks as well as gold. With the tools you've seen, you can easily follow a diversified strategy that offers a chance at strong returns over the long haul.

In the aftermath of the bear market, many investors have decided that the stock market is too risky for their money. As a safer alternative, they've looked to various types of bonds as a way to hedge their bets on a rising stock market. In particular, bonds can help you address the following concerns in your portfolio:

  • Liquidity. Too many investors found out the hard way that keeping all your assets in stocks can backfire during a bear market. By keeping enough money in more accessible short-term bonds in order to meet your immediate cash needs, you'll avoid having to sell your long-term investments at exactly the wrong time.
  • Deflation protection. Throughout the financial crisis, many have feared that the steep drop in housing prices and the stock market would spark a deflationary spiral that would cripple people with large debts. In contrast, bonds perform well in deflationary environments. You not only get back principal payments that have greater purchasing power than the money you originally invested, but you also collect interest along the way.
  • Higher income. On a more troubling note, the sharp drop in interest rates has forced many investors to change gears in search of investments that will produce more income. That has boosted demand for bonds, but it's unclear whether investors understand the risks they're assuming by moving money from low-yielding cash accounts to long-term bonds.

To meet the increasing demand, a number of bond ETFs are now available to investors. Here are just a few of them.

Take your pick
Even more so than stocks, bond ETFs are tailored to lots of different niches. For the broadest exposure to all sorts of bonds, a fund like the Vanguard Total Bond Market ETF (BND) includes bonds of all types, including Treasuries, agency bonds issued by government sponsored agencies like Fannie Mae (NYSE: FNM  ) and Freddie Mac (NYSE: FRE  ) , and corporate bonds. The fund also gives you a broad mix of bonds with different maturities, ranging from a few months to 30 years or more.

On the other hand, you can also find ETFs that narrow their focus. For instance, if you're interested in corporate bonds, the SPDR Barclays High Yield ETF (JNK) owns more than 100 high-yield junk bonds, with issuers such as AIG (NYSE: AIG  ) and Teck Resources (NYSE: TCK  ) . As of the end of November, the fund had risen 57% in the past year, buoyed by high demand and the nascent recovery. But it carries substantial risk, with more than a quarter of the ETF's bonds carrying a weak CCC rating or worse.

For those looking for safer corporates, the iShares iBoxx Investment Grade Corporate ETF (LQD) invests in higher-rated bonds. Wells Fargo (NYSE: WFC  ) , Wal-Mart Stores (NYSE: WMT  ) , and JPMorgan Chase (NYSE: JPM  ) are among the issuers whose bonds you'll find within the ETF.

You can find other ETFs specializing in just about any type of bond, from inflation-indexed bonds issued by the Treasury to municipals and mortgage-backed securities. And whichever one you find, investing can become as easy as buying shares of your favorite stock.

Rounding out your portfolio
ETFs are rapidly becoming the building blocks of successful investing strategies, and it's easy to understand why. With low costs, ease of use, and transparency, the right combination of ETFs may be all you need to build a winning portfolio.

Bonds are useful investments, but they aren't risk-free. Amanda Kish explains why you shouldn't be buying this junk.

Fool contributor Dan Caplinger has gone through the trials and tribulations of individual bond investing. He doesn't own shares of the companies mentioned in this article. Wal-Mart Stores is a Motley Fool Inside Value pick. The Fool owns shares of Vanguard Total Bond Market ETF. Try any of our Foolish newsletters today, free for 30 days. It doesn't get simpler than The Fool's disclosure policy.

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