WHEN YOU BUY BOTH corporate and Treasury bonds, you take interest-rate risk, meaning your bonds could fall in price if interest rates rise. But corporate-bond investors take an additional risk that government bondholders don’t have to worry about: There’s a chance the companies involved could default on their interest payments.
In addition, corporate bonds are often callable before maturity, meaning an issuer can pay off its bonds early. This can be bad news for investors, who may have to surrender a bond with a relatively attractive yield. That’s another risk Treasury investors don’t have to worry about.
To compensate for these risks, holders of higher-quality corporate bonds might collect an extra one to two percentage points in annual yield compared to Treasurys. That extra yield should provide a partial buffer against rising interest rates. Given the risk of rising interest rates, you might reduce your interest-rate risk by favoring shorter-term bonds, but stick with corporate rather than government bonds, so you don’t give up too much yield. There is, however, a price to be paid: When stocks nosedive, corporate bonds will likely provide less protection than government bonds.
Vanguard Group has a variety of low-cost corporate-bond mutual funds, both actively managed and indexed, that target securities with different maturities. A host of exchange-traded corporate-bond funds are available from BlackRock’s iShares, State Street’s SPDR ETFs and Vanguard.
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