Following the banner year for stocks, investors are reducing their risk profiles and adding a healthy dose of bonds to their portfolios. Exchange-traded bond funds saw the lion's share of net inflows through 2009, a trend which is continuing into 2010. There are currently 91 bond fund ETFs holding $106 billion in investor money, up from $57 billion just a year ago. With new products from PIMCO, iShares and the other major ETF sponsors the trend is sure to continue.

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Why Bond ETFs?
Bonds are gaining in popularity due to their placement in bankruptcy proceedings. As investors are toning down their risk, being higher on the food chain, so to speak, fixed income investing is one way to do this. In a worst-case scenario such as bankruptcy, the creditors and bondholders usually get at least some of their money back, while shareholders often lose their entire investment. Bonds can also be very efficient at smoothing out volatility and preserving capital. The regular income distributions bonds generate help cushion downside while still providing upside. Investors are flocking to bond ETF for their tax efficiency, low operating costs and transparency of ownership. These ETFs often make quarterly distributions, rather than semi or annual payments, unlike individual debt offers. The diversification benefits alone make ETFs one of the best investment vehicles out there for both institutional and retail investors. (Fixed-income investments can be part of your portfolio at any age. Find out how. Read Bonds For Every Stage Of Life.)

A Simple Fixed-Income Portfolio
While a broad based "catch all" bond ETF such as the iShares Barclays Aggregate Bond (NYSE: AGG), which owns 271 various bonds is a good low-cost choice for many portfolios, investors wanting to take a more hands-on approach to their fixed-income assets have several choices. Investors wanting to take full advantage of the various credit types and maturity timelines can build a quality portfolio that will keep up with rising interest rates and throw off enough income. Here is a simple fixed-income approach using some of the more popular and cheaper funds.

Bond ETF Choices
It's almost a guarantee that the Federal Reserve will raise interest rates sometime in the near future, although the next date is uncertain. In order to take advantage of this fact, investors should keep their maturities short. These short term bonds lose less than bonds of longer timelines. Corporate bonds traditionally pay larger coupons due to their "riskier' nature. The iShares Barclays 1-3 Year Credit Bond (NYSE: CSJ) follows 598 different short term investment grade corporate, and non-U.S. Agency bonds. The fund currently yields 3%, but as rates rise, so will the ETF's yield. A dose of short term United States Treasury bonds from the iShares Barclays 1-3 Year Treasury (NYSE: SHY) will help ratchet the safety level.


Just as the U.S government issues treasury bonds, so do other nations around the world. Adding a weighting of these international bonds will help protect the portfolio against a potentially falling dollar. The SPDR Barclays Capital International Treasury (NYSE: BWX) holds 84 bonds from various places around the globe including Canada, Germany and Japan. The fund currently yields 2.37%.

With the worst of the recession behind us, adding a weighting of high-yielding junk bonds makes sense as a growing economy should help keep defaults at a minimum. This fund will also bring up the overall income yield of the portfolio. The SPDR Barclays Capital High Yield Bond (NYSE: JNK) fits the bill.

Bottom Line
It seems these days that everyone is adding a bigger percentage of bonds to their portfolio. ETFs make it easy to add diverse fixed-income assets to a portfolio. The preceding bond ETFs are a good example of a starter bond allocation. (Learn more in An Introduction To Corporate Bond ETFs.)

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Tickers in this Article: CSJ, SHY, BWX, AGG, JNK

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