Consider medium- and short-term bond index funds now.
As interest rates have declined recently, bond investors have enjoyed healthy capital appreciation on their bond index funds. Unfortunately, now that the yield on bond market index funds is at an all-time low, bond investors need a new strategy to find the best fixed-income funds to buy. Bond yields reflect the credit quality and term of the underlying bonds. So a junk bond exchange-traded fund — which owns riskier, lower-quality bonds — will typically offer higher yields than an investment-grade U.S. bond index fund. Longer-term funds that own bonds maturing in more than seven years will be more volatile than shorter-term bonds, and they typically offer higher returns. The problem today when buying a bond index fund is that underlying bond prices decline as interest rates rise. It’s now prudent to consider medium- and short-term bond index funds for your investment portfolio. Here are seven of the best bond index funds to buy today.
Fidelity U.S. Bond Index Fund (ticker: FXNAX)
FXNAX is a conservative core holding for a bond market index fund portfolio. Don McDonald, host of the “Talking Real Money” podcast, prefers this Fidelity bond fund because 72% of the portfolio is rated AAA and the fund has a moderate 5.75-year duration. The duration is a way to measure how much bond prices are likely to change with interest rate movements. Shorter durations correlate with smaller price movements and greater durations suggest greater price changes when interest rates adjust. The fund’s benchmark is the Bloomberg Barclays U.S. Aggregate Bond Index. Nearly 41% of the fund’s holdings are in U.S. Treasury-related securities and 26% are in corporate bonds. FXNAX typically invests in at least 80% of bonds from that unmanaged index. The current distribution yield is 1.72% and the expense ratio is miniscule, at 0.025%.
Nuveen ESG U.S. Aggregate Bond ETF (NUBD)
Investors committed to environmental, social and corporate governance (ESG) investing might consider this fund from Nuveen, a firm with a long history of socially responsible investing, says Spencer Berndt, director of investment product research at UMB Bank. This core bond ETF is similar to FXNAX in that it also focuses only on investment-grade bonds. NUBD tracks the returns of the Bloomberg Barclays MSCI US Aggregate ESG Select Index, which follows predetermined ESG standards. The fund owns debt securities issued by the U.S. government, U.S. corporations, commercial mortgage-backed securities and other U.S. dollar-based bonds issued by non-U.S. governments and corporations. “These ESG parameters keep the fund out of problematic areas of the market and take away much of the single-issuer selection risk,” Berndt says. NUBD has an effective duration of 5.73 years. The current distribution yield is 2.21% and the expense ratio is 0.2%.
SPDR Portfolio Mortgage Backed Bond ETF (SPMB)
For the credit quality of U.S. Treasurys but a slightly higher yield, consider U.S. agency mortgage-backed securities, says Andrew Stewart, chief investment officer at Exchange Capital Management. U.S. agency bonds aren’t as liquid as Treasurys and also have prepayment risk, which helps explain their higher yield. Prepayment risk means that the underlying mortgage might be paid off prior to maturity. Subsequent mortgages added to the fund might have lower interest rates, resulting in reduced returns. The fund’s average duration is 2.41 years. The fund offers a 2.97% yield and charges a 0.06% expense ratio. For investors who are comfortable with additional risk, this mortgage-backed securities index ETF offers a cash flow boost.
Vanguard Short-Term Investment-Grade Fund (VFSUX)
Scott Pederson, financial advisor at Harmony Wealth Management, recommends VFSUX as a cost-efficient way to obtain exposure to short-term bonds. The fund’s objective is to provide income and minimal price volatility. This short-term bond index fund aligns with the Bloomberg Barclays U.S. 1-5 Year Credit Bond Index. The fund has about 80% invested in corporate bonds, which have higher credit risk and is hedged with exposure to lower-risk government and securitized debt, Pederson says. VFSUX holds 2,447 bonds with an average duration of 2.6 years. The 0.1% expense ratio gives investors affordable access to a diverse pool of investment-grade bonds. This short-term bond fund with a 2.4% distribution yield is a good alternative to low-yield money market funds for cash needed within the upcoming few years.
iShares Broad USD High Yield Corporate Bond ETF (USHY)
This low-cost, high-yield bond index ETF is an investment vehicle to complement other, more conservative bond funds. Brian Berkenhoff, founder of Birch Investment Management, suggests USHY for investors who are comfortable with increased risk and seeking higher yields. The fund is benchmarked against a U.S. dollar-denominated corporate bond index. Since the fund has more than 2,000 holdings, default risk is spread across many individual bonds. The 12-month trailing yield is 5.43%. Despite the lower credit quality of these bonds, the short effective duration of 3.76 years and low expense ratio of 0.15% make this fund compelling. Berkenhoff reminds investors that “high-yield bonds are still a risky investment and should not be the core of an investor’s bond portfolio.” He recommends approximately 10% of domestic bond exposure to this fund.
Vanguard Tax-Exempt Bond Index Fund (VTEAX)
A list of the best bond index funds would be incomplete without a nod to the tax-exempt offerings. Investors in higher tax brackets might receive higher after-tax returns with municipal bond funds. These tax-exempt funds are typically issued by states and municipalities and frequently offer greater after-tax yields than their taxable counterparts. Recommended by Asher Rogovy, chief investment officer at Magnifina, VTEAX is a stalwart in this sector — though ETF investors might prefer the Vanguard Tax-Exempt Bond ETF (VTEB). This municipal bond index fund tracks the returns of the S&P National AMT-Free Municipal Bond Index. Most of the bonds within the fund have an A or better credit rating. This intermediate-term bond fund holds nearly 5,000 bonds with an average duration of 5.1 years. The fund’s expense ratio is a low 0.09% and the 30-day yield is 1.06%.
WisdomTree Yield Enhanced U.S. Aggregate Bond Fund (AGGY)
For those craving a yield boost, Kevin Flanagan, head of fixed-income strategy at WisdomTree, suggests this unique approach to the typical bond index fund. AGGY re-weights the sectors of the benchmark Bloomberg Barclays U.S. Aggregate Bond Index in an attempt to improve yields while maintaining a safe risk profile. WisdomTree is known for its unique weighting strategies of index funds. AGGY leans to the longer term with a 6.82-year duration. The high-credit-quality bonds, with about 63% rated AAA, keep default risk low. AGGY is a mix of government, corporate and securitized bonds. The 12-month yield is 2.6%, although the current stated yield is 1.21%. Investors striving for high-credit quality and improved returns over typical index funds might consider this WisdomTree bond fund offering.
Seven best bond index funds to buy:
— Fidelity U.S. Bond Index Fund (FXNAX)
— Nuveen ESG U.S. Aggregate Bond ETF (NUBD)
— SPDR Portfolio Mortgage Backed Bond ETF (SPMB)
— Vanguard Short-Term Investment-Grade Fund (VFSUX)
— iShares Broad USD High Yield Corporate Bond ETF (USHY)
— Vanguard Tax-Exempt Bond Index Fund (VTEAX)
— WisdomTree Yield Enhanced U.S. Aggregate Bond Fund (AGGY)
More from U.S. News