(PUB) Investing 2015

The Independent Adviser for Vanguard Investors

•

September 2015

•

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800-211-7641

Long-TermTreasury

Sell.

Long-Term Government ETF

Sell.

Long-Term Bond Index

Sell.

Long-Term Corporate ETF

Hold.

Long-Term Investment-Grade

Hold.

Higher yields often make long-term

funds tempting, but that extra yield

comes with a cost—higher risk. And

with current yields ranging from 2.57%

to 4.84% among Vanguard’s long-term

funds, there isn’t that much extra yield

to be found here anyway. Double-digit

durations mean it wouldn’t take much

of a price decline to overwhelm the

income these funds generate. In the bal-

ance between risk and return, this group

leans decidedly more towards risk. I’d

rather stay shorter, and safer, than be

sorry.

But, if you’re of a mind to go for that

extra yield, I’d still favor the corporate-

oriented funds over the government-

focused ones. Consider that

Long-

Term Treasury

yields only 2.57% but

has a duration of 16.3 years. Similarly,

Long-Term Government ETF

yields

2.70% with a duration of 16.9 years. In

contrast, with

Long-Term Investment-

Grade

you are at least getting more

yield (4.09%) and a slightly shorter

duration (13.1 years). It’s the same story

of more yield and less duration with

Long-Term Corporate ETF

. Once

again, the index fund holding a mix of

government and corporate bonds,

Long-

Term Bond Index

, lands somewhere in

the middle with a yield of 4.01% and a

duration of 14.7 years.

I don’t recommend you buy any of

these long-maturity funds, but if you

have to, I’d pick Long-Term Investment-

Grade. This is the only bond fund at

Vanguard where

both

Wellington and

Vanguard share management duties.

Wellington’s Lucius Hill still is respon-

sible for the bulk of the assets, and has

shown an ability to take risk off the table

at the right times. Yes, the fund’s 16.8%

maximum decline in the credit crisis

looks bad, but it’s a good deal better than

Long-TermCorporate ETF’s 22.5% drop.

Short-Term Inflation Index

Hold.

Inflation-Protected Sec.

Hold.

First, let’s get on the same page and

understand what Treasury Inflation-

Protected Securities (or TIPS) are and

how they work.

TIPS are first and foremost Treasury

bonds, so like traditional Treasurys,

they essentially have no default risk.

However, unlike typical Treasurys,

there is an inflation-indexed compo-

nent to these bonds. The price of these

Treasury inflation bonds is tied to the

recent rate of inflation, and adjusted

every six months according to it. When

inflation is rising, the price of the

bonds goes up. Since the bond’s inter-

est (or coupon) rate remains constant,

the rising principal amount means your

payout also increases. The idea behind

these bonds is that investors’ real

returns, or returns above and beyond

inflation, should remain constant.

When considering an inflation fund,

one calculation that’s always worth

looking at is the spread (or difference)

between its current yield and that of

a Treasury fund with a similar matu-

rity. When the spread is small (i.e.,

the regular Treasury fund’s yield is

only slightly higher than the inflation

fund’s yield), you aren’t paying much

of a premium for inflation protection,

making the TIPS fund relatively attrac-

tive. When the spread is large, you are

paying a premium for that protection.

Today, the difference in yield between

Short-Term Inflation Index

and Short-

Term Treasury is 0.43%, or 43 basis

points. The spread between Inflation-

Protected Securities and Intermediate-

Term Treasury is 117 basis points. Both

spreads are below average, suggesting

insurance for inflation protection is on

sale. But before diving into either of

Vanguard’s inflation bond funds, here

are a few more things to consider.

The younger fund,

Short-Term

Inflation Index

, aims to track the

Barclays U.S. Treasury Inflation-

Protected Securities 0–5 Year Index and

will turn three years old in October. As I

said when the fund was first announced,

investors can see it as a money-mar-

ket alternative for cash that you don’t

need to spend tomorrow. Given that the

fund has sported a negative yield every

month except for two, it’s been a slow

first few years. The fund has not regu-

larly paid out quarterly income, only

distributing income at the end of each

year. Since the end of October 2012,

the fund is down 2.3%. With a yield of

just 0.17%, I wouldn’t expect this fund

to do much beyond preserving the pres-

ent value of your money, in inflation-

adjusted terms—and even that may be

a tall order.

Its older, actively managed sibling,

Inflation-Protected Securities

, also

provides protection from inflation, but

still holds long-maturity bonds and is

extremely sensitive to interest rates—the

average duration in the Vanguard fund is

8.1 years. Fast-rising interest rates knock

down TIPS prices, and if interest rates

increase faster than inflation does, TIPS

will see their prices decline.

Additionally, though TIPS are

Treasury bonds, they are not as popular

or as liquid as traditional Treasurys.

During the 2008 credit crisis, despite

holding high-quality bonds backed

by the U.S. government,

Inflation-

Protected Securities

’ portfolio did not

benefit from investors’ “flight-to-safe-

ty” and lost money on a total return

basis, down 12.5% at its worst.

While both of Vanguard’s inflation

funds can offer some diversification in

an income portfolio, I favor Short-Term

Inflation Index, which is less sensitive

to changes in interest rates. That said, I

prefer short-term corporate bonds over

short-term TIPS.

One final point to keep in mind is

that TIPS are particularly tax ineffi-

cient, since both their income and the

periodic price changes are fully taxable.

Both inflation funds are best used in a

tax-deferred account such as an IRA.

GNMA

Hold.

Mortgage-Backed Sec. ETF

Hold.

Mortgage-backed bonds are created

by pooling mortgages with similar rates

of interest and maturities. Monthly

interest and principal payments on

these mortgages are passed through to

bondholders. Mortgage-backed bonds

come in different flavors with different

levels of guarantees depending on who

pools together the mortgages and sells

the bonds. The Government National

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