Vanguard bond funds

Bond mutual funds give your portfolio the opportunity to earn income, unlike money market funds (which focus on maintaining your cash) and stock funds (which aim for long-term growth).

When included in a well-balanced portfolio, bond funds can help balance the risks associated with stock funds. Bond funds can also help you keep pace with inflation through inflation-protected bond funds. These funds, which invest in government bonds, are routinely adjusted for inflation.

By potentially holding hundreds—sometimes thousands—of bonds in a single fund, you get more diversification than you would buying individual bonds.

You can use just a few funds to complete the bond portion of your portfolio. Each of these index funds gives you access to a wide variety of bonds in a single, diversified fund.

• Vanguard Total Bond Market Index Fund holds more than 5,000 domestic investment-grade bonds.
• Vanguard Total International Bond Index Fund holds about 3,000 non-U.S. bonds.

There are a few questions to ask yourself while you're considering the right bond fund for your portfolio:

If you're in one of the highest tax brackets and investing outside of your retirement account, you may be able to reduce your tax exposure with a tax-exempt bond fund.

Cut your federal tax bill with a national tax-exempt fund. Get added state-tax savings if you live in:

• California
• Massachusetts
• New Jersey
• New York
• Ohio
• Pennsylvania

Investing in both U.S. and international bond funds can add another level of diversification to an already well-balanced portfolio.

Knowing the general traits used to identify the different bonds within a bond fund can help you determine your overall tolerance for risk.

• Average maturity. Bond funds come with short-, intermediate-, or long-term maturities. The longer the maturity, the more sensitive the fund is to changes in interest rates.
• Credit quality. Bonds that are backed by the government or one of its agencies have the best "creditworthiness" and a lower chance of default than most corporate bonds. Corporate bonds with high credit quality are considered investment-grade bonds, and those below investment grade are considered high-yield ("junk") bonds.

Do you feel more comfortable tracking the market, or would you rather try to beat it?

Index funds try to track the performance of a specific market benchmark—or index—as closely as possible. The fund manager buys all or a representative sample of the stocks or bonds included in the index.

Actively managed funds are steered by our expert portfolio managers who select specific securities for the fund. While this gives you the chance to beat the benchmark, any actively managed fund could just as easily miss the mark.