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I've been reading this board for a while recently, trying to go through all the posts (hey, it's only 628. Some boards get that many in a week!). This is partially my thinking about bond funds for my situation, and partially looking for any additional feedback.

I'm currently in the closing stages of paying off my credit card debt (rah!). Once that's finished, I'll be opening one (or more) brokerage accounts for my non-IRA savings.

The plan is to follow a "three bucket" approach to investing. Bucket A is an emergency fund (money I might need at any time); this will go into a money market account. Bucket B is money that I can't really afford to lose in the next three to five years. For example, I'm looking at making a down payment on a house within 3 years, and will be saving towards that goal. In true Foolish fashion, I'm not about to put that money in the stock market, as I can't afford to watch it drop 20%. (I'm not saying that will happen, only that it could). So bonds and other fixed income investments are the choice here

Bucket C is my long-term savings (money I won't need for at least 5 years). Currently, that is only retirement money (401(k)'s and IRA's), and all of that is in stocks.

I've been researching various "Bucket B" options. I've been looking at "laddered" CD's/Treasuries/whatever,a nd comparing them to bond funds. Laddered Treasuries seem like the best bet for owning individual instruments, as they can be bought at auction in denominations as low as $1,000 with no fees. But for me, there are a few problems:

A) I'll be mainly saving money in drips and drabs, and won't have $1,000+ handy on a regular basis. Also, I'd like to reinvest interest payments consistently, rather than shifting them to a money market fund until they accumulate more

B) If I want to hold to maturity, I'll have to purchase many treasuries that mature in under three years. A "ladder" into perpetuity or to match living expenses won't really work for me, as I'll need big chunk o' cash in about 3 years. Any other mony in bonds is essentially an extension to my "emergency fund"

C) If I'm not holding to maturity (need the cash for an emergency, or can buy a house earlier than expected), then I have the normal problems associated with bond fonds (potential of face value less than par if rates have risen), plus any commissions or whatever for selling individual bonds.

So for now I'm looking at opening an account with Vanguard, keeping my "Bucket A" cash in VMMXX (Vanguard's Prime Money Market Fund, which has one of the best current yields I've seen), and depositing "Bucket B" cash in at least one Vanguard Bond fund (leaning towards VBMFX, Vanguard's Total Bond Market Index Fund).

VBMFX has a minimum initial investment of 3K, but subsequent investments are as small as $100, IIRC, and I should be able to do direct deposit. Like all Vanguard funds, the expense ratio is VERY low (0.20%. There is no way I'm paying more than a fraction of a percent in expenses, which eliminates most bond funds). Over time, the bond fund's return will essentially be the bond yield, as the face value fluctuations go up and down but should zero out over time. Of course, in any given year the fund could go down in value, and if we had a repeat of the early 80's with interest rates shooting sky-high, I could get burned.

Vanguard has a break out of historical returns by capital and income return at their website, which is very helpful to me in looking at bond funds. I guess the best thing to do would be to compare the yield on those funds to the yields I can get on various mid-term Treasuries, but for now I'm leaning towards the Vanguard bond fund(s) over buying individual treasuries direct. (If I were looking at a constant income stream, then I'd probablt lean towards the treasuries instead).

Any comments or feedback would be appreciated. Thanks,

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