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More Fixed Income From Vanguard Funds: The Ultra-Short-Term Bond Fund

If you are looking for a way to earn higher returns than the near-zero yields of money market funds, there is a new addition to the Vanguard funds lineup you may want to consider for 2015.

Vanguard filed a registration statement with the Securities and Exchange Commission this week announcing its intention to introduce a new fixed income alternative, Vanguard Ultra-Short-Term Bond.

Scheduled to be available for investors to buy in early 2015, Vanguards announcement of the new ultra-short-term bond fund outlines their vision for and suitability of the fund. From Vanguard CEO Bill McNabb:

Vanguard Ultra-Short-Term Bond Fund is a low-cost and diversified option for investors seeking to augment the bond component of a balanced portfolio. It will afford investors the opportunity for further duration diversification.

In different words, the new Vanguard Ultra-Short-Term Bond Fund will offer the potential for higher returns than money funds without the added risk of bond funds with longer durations. But is this new addition to the Vanguard funds lineup appropriate for you and your portfolio? What are the pros and cons of investing in ultra-short-term bond funds?

The Portfolio and Expenses of Vanguard Ultra-Short-Term Bond Fund

The Ultra-Short-Term Bond Fund will be managed by the Vanguard Fixed Income Group, which according to Vanguard is one of the worlds largest fixed-income managers with nearly $802 billion in assets under management in 51 bond, money market and stable value funds.

The fund will invest in a diversified portfolio of money market securities and high-quality bonds with an expected average rating of Aa. The majority of securities will have an expected maturity of zero to three years and will generally be held until maturity. The fund is expected to have a duration of 0.75 to 1.25 years, with a target of close to one year.

Like most of the current Vanguard funds, Vanguard plans to offer two share classes Investor shares and Admiral shares. The Investor shares have an estimated expense ratio of 0.2% and will have a minimum initial investment amount of $3,000, while the Admiral Shares have estimated expenses of 0.12% and a minimum initial purchase of $50,000. All shares will be available for purchase by all investors; therefore, there will be no purchase constraints or limitations beyond the initial minimums.

Why Invest in Ultra-Short-Term Bond Funds?

As Vanguard CEO Bill McNabb suggested, adding an ultra-short-term bond fund to a portfolio of mutual funds can reduce the interest rate risk of the fixed-income portion of the portfolio.

With interest rates expected to rise in 2015, the beginning-of-the-year timing to make the ultra-short-term bond fund available to investors is no accident. When interest rates are rising, bond prices generally are falling, and the longer the duration of a bond, the greater its sensitivity to interest rates and thus the deeper the decline in price.

Therefore, assuming interest rates do finally begin their new ascension in 2015, the bond funds with the shortest durations will fall in price the least.

But investors should be cautioned that ultra-short-term bond funds are not free of principal risk and should not be considered a replacement for money market funds.

However, if you are in the market for buying an ultra-short-term bond fund, this new addition to the Vanguard funds lineup is a worth your consideration. The low expenses, seasoned management and the expected high assets that Vanguard funds typically attract can combine for above-average returns and high liquidity necessary for success in the fixed-income world.

As of this writing, Kent Thune did not hold a position in any of the aforementioned securities. Under no circumstances does this information represent a recommendation to buy or sell securities.

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