Bond ETF: Safety With Liquidity and Flexibility?

Bond exchange trade funds (ETFs) are very well represented in the world of investing. Selections from Barclay's Global Investors alone come in six variations. They include short-term treasury bonds (SHY), medium-term treasury bonds (IEF), long-term treasury bonds (TLT), inflation protected treasuries (TIP), corporate bonds (LQD), and a broad bond market index (AGG). The list isn't quite complete though. Foreign bonds are not at all represented. I suspect there'll be a filing for such an ETF soon.

I keep a portion of my portfolio in bonds. Some argue that the current environment of rising interest rates is detrimental to bond funds. But keeping inline with my ETF investing philosophy I continue to hold my positions for the day when they return to favor. However, I do keep my holdings fairly simple. I purchase the higher-yielding, but more risky corporate bond ETF and the broad bond market ETF.

There are two reasons to consider investing in a bond exchange traded fund. The first is to provide a relatively steady stream of income. If you're older, you may appreciate the stability that comes from income generating investments. The other reason is to decrease overall portfolio volatility because bonds and stocks often don't move in concert with each other. However, be careful to not overweight your bond holdings if you're young as you run the risk of decreasing portfolio returns.

Note that bond funds differ from bonds in that they have no par value. As such a bond fund can lose value and never recapture it. On the other hand, a recent article by Investment Advisor reports that in the 10 year period ending 1997, no bond fund outpaced the Lehman Aggregate Bond Index. In addition, in the following 10 year period, only 10% of bond funds have been able to outperform the index. Think you've got what it takes to find one of those rare funds?

According to a post from Seeking Alpha,
“AGG sits in the sweet spot of very low credit risk, reasonably short duration and attractive yield.” For more information specifically about bonds and indirectly about bond ETFs, consider this viewpoint from PIMCO.