Investments that pay a return on a fixed schedule
The Federal Reserve confirmed in its January 2021 meeting that it will keep its target federal funds rate between 0% and 0.25% and that it expects to maintain this low interest rate environment until the labor market reaches maximum unemployment and inflation is back to 2%. Despite rates being near zero, fixed-income investments continue to offer investors some stability compared with volatility they might expect to experience in the equity market. A fixed-income investment involves an issuer or a borrower making payments to a lender or investor at a set date for a set amount. In the current low interest rate environment, most financial advisors suggest investors hold short- and intermediate-term funds that will offer buyers some flexibility if rates rise. Here are eight of the best fixed-income funds to consider for today’s market.
Vanguard Short-Term Corporate Bond ETF (ticker: VCSH)
Kristian Finfrock, founder of and financial advisor at Retirement Income Strategies, says “fixed income is challenging today for investors, given that interest rates are historically low and there’s a lot of uncertainty looking toward the future.” Because of that, some financial advisors aim to keep their clients who need fixed income in short-duration investments — that means holding funds with five years or less before they mature. “I like high-quality, short-duration (investments) because you’re decreasing your risk that interest rates will rise in the long term,” Finfrock says. A good example of a short-duration exchange-traded fund is VCSH. It tracks the performance of the Bloomberg Barclays U.S. 1-5 Year Corporate Bond Index, which has a short-term dollar-weighted average maturity. U.S. News & World Report ranks VCSH among the top 10 funds in short-term bond portfolios. It comes with an ultra-low expense ratio of 0.05%.
DFA Short-Term Extended Quality Portfolio (DFEQX)
Justin Halverson, partner and lead advisor at Great Waters Financial, says he uses a few different fixed-income funds for clients to get both the protection they provide in a portfolio during stock market sell-offs and the yield for clients who need income. In the last year, fixed income was a saving grace, Halverson says. DFEQX has a mix of cash and domestic and foreign bonds. “To get the drivers and growth that we need, sometimes we have to extend the duration or the quality to get bigger returns,” he adds. “This is a year where taking a diversified approach makes sense.” U.S. News ranks DFEQX as No. 43 out of more than 100 short-term bond funds.
DFA Five-Year Global Fixed Income Portfolio (DFGBX)
Traditionally, many retail investors have been underweight in foreign holdings — including on the fixed-income side of their portfolio’s asset allocation. Halverson says he uses DFGBX as a way for his clients to make up for this global exposure. The fund’s objective is to give investors a market rate of return for fixed income and to do so with relatively low volatility. The fund can hold investments that run up to five years in maturity, but the vast majority of holdings are very short-term durations — in the zero-to-three months time frame — or will mature in one to three years. It uses the FTSE World Government Bond Index (one to five years, hedged to the U.S. dollar) as its benchmark. The fund’s expense ratio is 0.26%.
Fidelity U.S. Bond Index Fund (FXNAX)
The purpose of holding bonds in a portfolio is to provide a reasonable degree of stability, says Don McDonald, financial advisor at Vestory. FXNAX can act as a core investment-grade bond holding in a portfolio. McDonald notes that the fund focuses on high-quality investments, “so that internal losses, due to default, are nearly impossible.” The fund tracks the Bloomberg Barclays U.S. Aggregate Bond Index, which includes investment-grade, U.S. dollar-denominated bonds with at least one year until maturity. McDonald also says that FXNAX holds bonds with “reasonable” durations of five to seven years, which means the fund won’t be too affected by rising interests. The fund comes with a low annual cost of 0.025% and a trailing 12-month yield of 2.07%.
Vanguard Total Bond Market Index Fund (VBTLX)
Another fund McDonald recommends is VBTLX, which has similar qualities as FXNAX, offering stability and an average duration of more than six years. The fund also holds high-quality assets — and plenty of them, with roughly 10,000 bonds. Even if there is a default of one of the holdings, “in the rare case where that occurs, the effect will be small, as it is so broadly diversified,” he says. The fund has a low fee of 0.05% and a yield of 2.23%. All those factors help make it a solid choice for a core holding. “When you own the entire world, it is impossible to lose all of your money in any situation short of a planetary extinction event or zombie apocalypse,” he says.
FlexShares iBoxx 5-Year Target Duration TIPS Index Fund (TDTF)
Leslie Falconio, senior fixed-income strategist at UBS, says U.S. Treasury inflation-protected securities — known as TIPS — are her firm’s preferred allocation for a U.S. Treasury holding. Specifically, Falconio points to the five-year area for TIPS because of its higher correlation to crude oil and the global economic recovery. One example of a five-year-duration TIPS ETF is the FlexShares iBoxx 5-Year Target Duration TIPS Index Fund. The fund holds TIPS with maturities between three and 20 years, but it targets a duration of roughly five years. TDTF has an expense ratio of 0.18%.
Invesco National AMT-Free Municipal Bond ETF (PZA)
Josh Simpson, investment advisor with Lake Advisory Group, says his firm uses PZA in taxable accounts because, as a municipal bond fund, it’s primarily invested in securities that are exempt from the federal alternative minimum tax. PZA tracks an index of investment-grade, tax-exempt debt publicly issued by a U.S. state. The holdings will have at least 15 years remaining to maturity, although the average duration is around 8.8 years. The fund has higher yields for a muni bond fund with average credit risk. It has around $2.3 billion in assets under management and a relatively low expense ratio of 0.28%. “With interest rates so low, there’s really not a lot of options available,” he says. But with a yield of 2.44%, it’s a good option, especially since it’s untaxed.
Vanguard Intermediate-Term Bond ETF (BIV)
BIV tracks an index of the entire investment-grade market, in which maturities range from five to 10 years. The fund has a yield of 2.24% and a low expense ratio of 0.05%. This is a good core holding for an investor’s tax-sheltered account. Simpson says he likes to use this ETF focused on corporate bonds because it has a medium duration — meaning that if interest rates do rise, the fund isn’t stuck with holdings that won’t mature for a long time. Like PZA, he says BIV is a good placeholder fund to have while waiting for bond yields to improve.
Top fixed-income funds for your portfolio:
— Vanguard Short-Term Corporate Bond ETF (VCSH)
— DFA Short-Term Extended Quality Portfolio (DFEQX)
— DFA Five-Year Global Fixed Income Portfolio (DFGBX)
— Fidelity U.S. Bond Index Fund (FXNAX)
— Vanguard Total Bond Market Index Fund (VBTLX)
— FlexShares iBoxx 5-Year Target Duration TIPS Index Fund (TDTF)
— Invesco National AMT-Free Municipal Bond ETF (PZA)
— Vanguard Intermediate-Term Bond ETF (BIV)
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