Q&A: Add Foreign Bonds?

Q:

Big fan of your show(s) and was wondering what you think of Vanguard's recommendation (and inclusion) of the total international bond index fund in their target date retirement funds. Is this something you would recommend as part of one's core bond holdings since it increases diversification, could decrease volatility and is hedged?
-Richard

A:

So far, I remain somewhat ambivalent about the value of international bonds in a diversified portfolio. I am torn between my love of diversification and primary reason we hold bonds: safety.

Foreign bonds (and I would still suggest using shorter term, quality government paper) add an extra component of volatility: currency risk. With a typical portfolio of short/intermediate term U.S. Treasuries volatility comes from one factor: interest rates. Some studies have shown that there is a slight non-correlation between foreign and U.S. bonds that could outweigh the currency exchange volatility, but the extra expenses for foreign bond funds could diminish that effect. For now (but my mind can be changed with additional data), I prefer keeping it simple and cheap, with only U.S. bonds.
-Don