CashNews.co
The performance of Vanguard Long-Term Bond ETF (NYSEMKT: BLV) improved ahead of the Federal Reserve’s fed funds rate cut in September. That makes complete sense, given the nature of long-term bonds.
But before you rush out and buy this exchange-traded fund (ETF), you should understand both the positives and negatives of owning it. Here’s why you might want to buy this ETF, as well as why you might prefer to own a short-term bond ETF instead.
What does Vanguard Long-Term Bond ETF do?
Without getting into the nitty-gritty of the investment approach, the Vanguard Long-Term Bond ETF buys long-term bonds that are investment-grade rated. That ends up being a mix of U.S. government bonds (about 50% of the portfolio) and corporate bonds that are rated BBB or higher. The current breakdown on corporate bonds is 1.4% AAA, 5.7% AA, 20.8% A, and 22.7% BBB. Note that Vanguard isn’t specifically trying to avoid the highest-quality bonds (AAA and AA) — there are simply not that many bonds that qualify for such high ratings.
Image source: Getty Images.
That said, it is important to differentiate between what you might do as a bond investor and what a pooled investment vehicle, like an ETF, has to do. By mandate, this ETF has to own long-term bonds. Each year that passes means that there are new bonds issued and older bonds that have maturities that no longer qualify as long-term or that simply get repaid.
Vanguard Long-Term Bond ETF has to update its portfolio so it continues to represent the long-term bond market it is attempting to track. You, as an individual, might buy a long-term bond and simply hold it until maturity. These are very different approaches.
For example, if you acquire a long-term bond with a high yield (say, 10%) you would probably never sell it. You’d collect that 10% interest rate until the bond matured and wouldn’t pay too much attention to the market price of the bond. But an exchange-traded fund meant to track long-term bonds will have to sell it well before that point once its remaining maturity no longer qualifies as long-term. That could result in either a profit or a loss on the bond, and then that bond will be replaced with a newer bond that is offering interest at the then-current rate.
Simply put, the cash you collect in dividends from Vanguard Long-Term Bond ETF will fluctuate over time, and so will the value of the ETF. That’s a risk with any bond ETF that isn’t structured to buy and hold to maturity (there are some that do just that).
Long-term bonds are riskier than you may think
This is where the story gets more interesting because long-term bonds tend to be much more sensitive to interest rate changes than shorter-term bonds. This is just the nature of long-term bonds. But it means that the price swings of Vanguard Long-Term Bond ETF can be far more dramatic than some investors might be comfortable with.
BLV data by YCharts
The graph shows just how dramatic the swings can be. Notice the orange line, which represents the price performance of Vanguard Short-Term Bond ETF (NYSEMKT: BSV). It pretty much remained stable over the past decade. That’s because the interest paid on short-term bonds resets more quickly when interest rates change.
But Vanguard Long-Term Bond ETF’s price (the purple line) has risen and fallen in far more dramatic fashion as interest rates (the blue line) have changed. This is normal. If you can’t stomach that kind of volatility, you probably shouldn’t own long-term bonds.
How much are you getting paid?
The problem is that short-term bonds generally have lower interest rates than long-term bonds. So Vanguard Short-Term Bond ETF has a yield of 3% versus a yield of nearly 4.3% on Vanguard Long-Term Bond ETF. On an absolute basis, that’s not much of a difference, but percentage-wise, it’s roughly 40% more income.
That’s meaningful and helps explain why some investors might be attracted to the long-term bond space. However, if you are a conservative investor, the increased risk of owning a long-term bond ETF might not be worth it for you.
This is particularly important to remember today, as the Federal Reserve appears to be shifting toward lowering interest rates. What that means for investors is that long-term bond ETFs like Vanguard Long-Term Bond ETF are going to be standout performers as rates fall. But don’t forget the other side of that equation, since the same ETFs will underperform when rates head higher again. If you want a “set it and forget it” portfolio, Vanguard Short-Term Bond ETF will probably be a better long-term option.
Should you invest $1,000 in Vanguard Long-Term Bond ETF right now?
Before you buy stock in Vanguard Long-Term Bond ETF, consider this:
The Motley Fool Stock Advisor analyst team just identified what they believe are the 10 best stocks for investors to buy now… and Vanguard Long-Term Bond ETF wasn’t one of them. The 10 stocks that made the cut could produce monster returns in the coming years.
Consider when Nvidia made this list on April 15, 2005… if you invested $1,000 at the time of our recommendation, you’d have $728,325!*
Stock Advisor provides investors with an easy-to-follow blueprint for success, including guidance on building a portfolio, regular updates from analysts, and two new stock picks each month. The Stock Advisor service has more than quadrupled the return of S&P 500 since 2002*.
See the 10 stocks »
*Stock Advisor returns as of September 30, 2024
Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard Bond Index Funds-Vanguard Short-Term Bond ETF. The Motley Fool has a disclosure policy.