Why the Vanguard Total Bond Market ETF Is a Smart Choice to Diversify Your Portfolio

It'd probably be safe to say that bonds have spent much of the past 20 years failing to present a real investment case.

Following the 2008 financial crisis, the Fed dropped interest rates to 0%. Short-term bond funds saw their yields drop to next to nothing. Longer-term bond funds were still able to produce yields of around 2%, but they were no longer the income generator they once were.

Any attempts to raise interest rates damaged share prices. This dynamic peaked in 2022, when inflation jumped to around 9%, the Fed was forced to aggressively raise rates, and the Vanguard Total Bond Market ETF (NASDAQ: BND) fell by nearly 20%.

BND Total Return Price data by YCharts.

Today, conditions are much improved. Long-term yields have stabilized, and this fund's 4.2% yield makes it a contributing part of a diversified portfolio once again.

If you're looking to add broad bond market exposure to your portfolio in order to mitigate overall risk and improve income, the Vanguard Total Bond Market ETF remains one of the best options for doing this.

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What is the Vanguard Total Bond Market ETF?

This ETF tracks the Bloomberg US Aggregate Float Adjusted Index. It's designed to invest in a broad array of U.S. investment-grade, intermediate-term government bonds, corporate bonds, and mortgage-backed securities (MBS). In essence, it's a one-stop shop for the fixed-income market.

Currently, the portfolio consists of about 68% government securities, broken down roughly between 49% Treasuries and 19% MBS. The remainder is mostly corporate bonds, with minor allocations to other credit types.

Some will argue that the near-70% allocation to U.S. government securities is too high for a diversified portfolio. Truthfully, I'd prefer to see a little more corporate bond exposure in here. Something like the Vanguard Total Corporate Bond ETF could be added here to tilt the exposure somewhat. But overall, the current allocation of the Total Bond Market ETF works just fine for a long-term portfolio.

Attractive income without excessive risk

What the Vanguard Total Bond Market ETF does particularly well is provide complete bond market coverage without any excessive tilts that could significantly alter the overall risk/return profile.

By focusing on investment-grade securities with medium-term remaining maturities, you avoid the additional risk that comes from junk bonds and the longer-term bonds that can come with excessive interest rate sensitivity. By shooting straight down the middle, you get a blended fixed-income portfolio that keeps quality high and interest-rate risk in check.

The 4% yield also provides a meaningful incentive to keep at least some portion of your portfolio allocated to bonds. With equity market gains beginning to lose momentum, parts of the economy and labor market starting to show vulnerabilities, and investors appearing a little less tolerant of risk, the Vanguard Total Bond Market ETF serves as a strong balance to an equity-heavy portfolio.

David Dierking has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard Total Bond Market ETF. The Motley Fool has a disclosure policy.