Why I Sold My Individual Bonds and Moved Everything Into 1 Bond ETF

Investors are often taught the virtues of diversification when it comes to stocks. It's an excellent idea to build equity portfolios comprised of numerous stocks and exchange-traded funds (ETFs), preferably across a variety of industries and sectors, so that when one asset sneezes, the whole portfolio doesn't catch a cold.

The wisdom of diversification is also applicable to bonds. For investors who are new to the fixed-income arena, note that while bonds won't match stocks for long-term upside, they are useful for generating income, diversifying portfolios, and potentially limiting volatility when the stock market is turbulent.

The Vanguard Total Bond Market ETF is a better idea than owning individual bonds. Image source: Getty Images.

However, some of those perks can be mitigated when buying individual bonds. Select the wrong issue, and an investor can limit their income potential or bite off a bond that's highly correlated with stocks, muting their portfolio's diversification.

In other words, as is the case with owning just one stock, it's risky to own a single bond. The Vanguard Total Bond Market ETF (NASDAQ: BND), the largest fixed-income ETF, solves that problem.

I let BND do the bond work for me

These days, investors are hearing plenty about interest rates. That situation is amplified by the fact that the Federal Reserve recently raised rates and is expected to do so once more before the end of 2026 as part of its effort to quash inflation.

Rising rates are also a reminder that when investing in bonds and ETFs, such as the Vanguard fund, for that matter, there are two forms of risk that market participants must consider: rate risk and credit risk. Both of those potential headwinds highlight the advantages of considering a broad-based ETF such as this Vanguard fund.

For example, 30-year Treasuries don't carry much credit risk; not yet anyway. But if rates rise by 1%, those funds can subject investors to deep double-digit losses, which is to say a bond many investors view as risk-free is far from that.

Further underscoring the perks of an ETF, such as the Vanguard fund, is its low credit risk. There is a slew of high-yield corporate bonds, also known as "junk" bonds, on the market sporting yields well in excess of those of the S&P 500, long-dated Treasuries, and even many high-dividend stocks. But pick the wrong junk bond, and an investor could endure credit downgrades, or worse, defaults, and see the value of their investment greatly diminished.

Though not perfect at eliminating interest rate or credit risk, the Vanguard ETF has at least one big thing going for it: It holds 11,421 bonds. The ETF's holdings span a variety of maturities, and with more than 62% of the fund's roster comprising Treasuries and other U.S. government debt, credit risk is relatively tame. Said another way, this fund solves multiple problems for bond investors under one umbrella, and that's a good thing.

Capital considerations

Another point highlights the advantages of this Vanguard ETF: Investing in individual bonds requires a lot of money. Sure, the Treasury Department will allow me to buy Treasuries for as little as $100, but if I want to buy the same bonds through a brokerage firm where I hold stocks, I'd have to buy them in $1,000 increments.

The same is true with corporate bonds. If I want to purchase two newly issued corporate bonds, I'd have to dole out $2,000 because bonds are issued in $1,000 increments. Municipal bonds are sold in $5,000 increments.

So I'd need a lot of capital to build an adequately diverse bond portfolio constructed with individual issues. Or I can choose to pay barely more than $70 to buy a share of the Vanguard Total Bond Market ETF and enjoy the rock-bottom annual fee of 0.03%, or $3 on a $10,000 investment, all while getting more diversification than I would with a single bond.

Todd Shriber 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.