Income-focused investors are always looking for ways to increase what their portfolios generate. However, a balance needs to be found between risk and reward.
Bonds are no different than stocks in this regard, but there are different issues that have to be considered. Here's why the Vanguard Intermediate-Term Corporate Bond ETF (VCIT 0.77%) could be the healthy middle ground that you are looking for.
What does the Vanguard Intermediate-Term Corporate Bond ETF do?
Bonds are actually more complex than stocks in many ways, given that each individual bond is its own security. With a stock, each share of a company is the same as every other share. The bond market is also much larger than the stock market. Investors shouldn't go into bond investing thinking that it is simple or low risk.
Image source: Getty Images.
Although each individual bond has its own characteristics, there are two broad issues that investors need to consider. The first is issuer risk, which can be summed up as "Can the borrower pay?"
Then there's duration risk, which is all about the length of time before the bond matures. Longer bonds have higher risk than shorter bonds, since there's more time for bad things to happen to the borrower. There's also more time for inflation to eat away at the value of the interest payments and the bond principal.
On the issuer risk side, the two lowest-risk options are U.S. government issued bonds and investment-grade rated corporate bonds. Essentially, these are the borrowers with the strongest balance sheets.
The U.S. government, notably, can simply create more money to repay its debt. That wouldn't necessarily be a great outcome because it would create inflation, but lenders would get their money. That extra layer of security, however, leads U.S. government bonds to have lower yields than investment-grade corporate bonds.
The Vanguard Intermediate-Term ETF is looking for a healthy balance between yield and risk by focusing on investment-grade corporate bonds that have remaining maturities between five and 10 years.
How has this Vanguard ETF done?
As the chart above highlights, the Intermediate-Term Corporate Bond ETF's price performance has been roughly similar to that of the Vanguard Intermediate-Term Treasury Bond ETF (VGIT 0.37%).
However, the Corporate Bond ETF's total return, which includes the reinvestment of dividends, is much better. That's because it offers a higher yield, currently around 4.4%, versus the Treasury Bond ETF's nearly 3.7%. As the chart below highlights, that yield advantage is pretty much par for the course.
VGIT Dividend Yield data by YCharts.
So, if you are thinking about government bonds or high-quality corporate bonds, it seems like the corporate option wins out on the yield front. But what about intermediate-term duration bonds versus other corporate choices?
The chart below shows what you would expect: Short-term corporates tend to have the lowest yields, while long-term corporates tend to have the highest yields. The Vanguard Intermediate-Term Corporate Bond ETF sits in the middle.
VCIT Dividend Yield data by YCharts.
The same breakdown comes on the risk side, as well. The past decade was a difficult one for bonds because of the increase in interest rates over the past few years. However, the Vanguard Short-Term Corporate Bond ETF (VCSH 0.35%) lost the least, the Vanguard Long-Term Corporate Bond ETF (VCLT 1.39%) lost the most, and the intermediate-term choice was right in the middle. But the Vanguard Intermediate-Term Corporate ETF was much closer to the short term than the long term, price volatility wise.
VCIT Total Return Level data by YCharts.
Which brings up the next, and perhaps the most important, chart. Looking at total return over the past decade (which assumes dividend reinvestment), the Vanguard Intermediate-Term Corporate ETF's middle-ground yield and middle-ground price performance resulted in a better total return than either the Short-Term Corporate Bond ETF or Long-Term Corporate Bond ETF. In other words, the Intermediate-Term Corporate ETF is a very happy middle ground between risk and income.
Not the best for everyone, but a good choice for most
There are clearly situations where the the Intermediate-Term Corporate Bond ETF won't be the best option for an investor in the short term. But if you have a long time horizon and are trying to maximize income while minimizing risk, it could be a solid core holding for your income portfolio.
