Key Points
The recent bond market sell-off has driven interest rates up -- and bond prices down.
The Vanguard Total Bond Market ETF (BND) is an easy, low-cost way to buy a diversified mix.
If bond yields (and interest rates) go higher in the future, current bonds would lose value.
The bond market is going through some turmoil right now. Experts are calling it a "global bond market sell-off." Bond yields on major countries' government debt, such as the 10-year U.S. Treasury bond, have spiked by 1% or more within the past year. Investors seem to be selling bonds, demanding higher yields, and casting doubt upon the creditworthiness of the U.S. government.
You know what? I'm going to buy more bonds. That's right: even though lots of other investors right now are selling bonds, I'm going to keep buying them. In the same way that "buying the dip" on stocks when stock prices are low is often a good long-term investment, I'm going to "buy the dip" on bonds when bond yields are high.
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Let's look at why now could be a good time to buy bonds, and which bond ETF I'm buying.
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Is now a good time to buy bonds? Lock in 5% risk-free yields
Why do people buy bonds in the first place? It's because they want to get paid consistent income with lower risks than the up-and-down roller coaster of the stock market. The yield paid by U.S. Treasury bonds is known as the "risk-free rate of return," because when you buy bonds from the U.S. government, you're guaranteed to get your money back in full, plus interest. The U.S. government has never defaulted on its debt, and almost definitely never will.
But when bond yields go up, the prices of existing bonds go down. That means rising interest rates (higher bond yields) are for investors who currently hold bonds paying yesterday's lower yields, but can be good for buyers of newly issued bonds at today's higher rates.
No one knows what's going to happen next with bond yields, U.S. national debt, or the overall economy. But I'm not panicking about the recent upward moves in bond yields. I don't believe that we're on the verge of recession or a U.S. national debt crisis. I believe in steady, consistent investing in a diversified portfolio of low-cost index funds, and bond ETFs are part of that mix.
Vanguard Total Bond Market ETF (BND): 11,421 bonds, 5.14% yield
The Vanguard Total Bond Market ETF (NASDAQ: BND) is, for my money, the best way to buy bonds for most American individual investors. I buy more of this bond ETF on every payday, every time I add more money to my investment accounts.
The bond market is complicated -- to me, even more than the stock market. This Vanguard bond fund makes it simpler. When you buy BND, you are buying shares of 11,421 bonds of all kinds within the U.S. bond market. These are generally low-risk bonds. Most of the fund's assets (about 69%) are in U.S. government bonds, and the rest are in corporate bonds with high credit ratings, also known as "investment grade."
As of October 8, BND is paying a 30-day SEC yield of 5.14%. If you buy bonds with this ETF right now, you're likely to earn a yield to maturity of 5.5%. And as the fund's bond holdings reach maturity, the fund will automatically buy more bonds at today's higher yields.
Risks and opportunities of BND
Keep in mind that just because a bond ETF is paying a yield of 5% (or more), that doesn't mean it will deliver a return of exactly 5%. Bonds are not risk-free. BND has delivered a negative total return of -1.85% in the past year:
BND (and other bond ETFs) lost value in the past year because interest rates went up in the past year. That made the prices of this bond ETF's existing holdings go down. Even though those bonds were paying a steady yield, the value of those lower-yielding bonds declined, based on today's higher bond yields.
But I believe that bond yields aren't going to keep going up forever. The 10-year Treasury yield recently reached its highest level since 2002. But this isn't far out of line with its historical averages. What if bond yields don't spike much higher from here? What if most of the bond losses are already priced in?
10 Year Treasury Rate data by YCharts
I believe there is upside potential for buying bonds right now -- like "buying the dip" on stocks after a price decline. 5% (or more) bond yields are worth locking in. Interest rates could go down in the next 10 years, which would make today's lower price of the Vanguard Total Bond Market ETF look like a good buy.
Ben Gran has positions in Vanguard Total Bond Market ETF. The Motley Fool has positions in and recommends Vanguard Total Bond Market ETF. The Motley Fool has a disclosure policy.