Bond funds offer diversification to stocks.
With interest rates at historically low levels, bonds don’t produce the yield they once did for retirees. However, many investment advisors still see the need to hold bond funds for retirement in portfolios. Don Bennyhoff, director of investor education at Portfolio Solutions, says bonds offer the portfolio diversification investors need. “The majority of our clients still have a healthy amount of stocks in their portfolio, which is very common,” he says. “The diversification benefits from bonds, through helping temper that volatility, is a significant dividend, even if (what) the bonds are paying isn’t great.” According to Bennyhoff, investors were coached for so long to only look at yield rather than total return, which is yield and price appreciation. Here are eight of the best bond funds for retirement.
Vanguard Tax-Exempt Bond ETF (ticker: VTEB)
For investors who want a bond exchange-traded fund that’s free from federal income tax, VTEB is “a great choice,” says Todd Rosenbluth, director of ETF research at CFRA. He points out that it’s “extremely cheap” with an annual expense ratio of 0.06%, or $6 per every $10,000 invested. The fund is diversified across various states and municipalities and has a focus on investment-grade bonds. “There’s strong liquidity within the portfolio,” Rosenbluth says, as it holds around 5,900 different bonds, and he adds that bonds are removed if they fall from investment grade to junk. “This is a great core federal tax-free offering,” he says. It also comes with a current 12-month yield of 1.83%.
Invesco National AMT-Free Municipal Bond ETF (PZA)
Income is hard to come by with interest rates so low, which makes municipal bonds, or “munis,” a good choice for investors since the yields are free of federal tax. Josh Simpson, investment advisor with Lake Advisory Group, points out PZA’s current yield is 2.3%, which is nearly one percentage point higher than the U.S. 10-year Treasury yield. It also has a low expense ratio of 0.28%. The fund buys investment-grade muni bonds from across the country and trades them out as rates start to rise. Although it’s an index fund, PZA is rebalanced and reconstituted monthly, which allows managers to swap out lagging securities. It gets a higher yield by holding longer-dated securities, at least 15 years or longer, and weights holdings by market value.
Pimco Active Bond ETF (BOND)
The Pimco Active Bond ETF is another of Rosenbluth’s picks for a core bond fund. “Active management has demonstrated success versus the Barclays Aggregate Index,” he says. The fund has exposure to investment-grade corporate and government-oriented bonds, but it also has some exposure to emerging-market bonds and high-yield credit, which helps boost the yield to 2.53%. BOND costs 0.57% annually, which he says “is reasonably priced for a for an active strategy.” This is an intermediate bond fund, with an effective duration of 5.91 years.
iShares Core 1-5 Year USD Bond ETF (ISTB)
Rosenbluth says if investors worry about interest rates rising in the future, a short-term bond strategy could be a good option. As its name implies, ISTB holds bonds with one to five years left to maturity, which lowers interest-rate risk. It’s another cheap ETF, with a 0.06% annual expense ratio. This fund has about 95% dedicated investment-grade debt with a small exposure to high-yield bonds to help boost yield while taking on a little credit risk. “It’s got a healthy mix of risk: lower risk on the rate side, but taking on some credit risk, and that helps to offer some income,” he says.
Shenkman Capital Floating Rate High Income Fund (SFHIX)
Kristian Finfrock, founder of Retirement Income Strategies, says rates are likely to rise in the next few years, and investors need to be prepared. He likes SFHIX because it produces high income — its current yield is 3.34% — and because, as a floating-rate fund, it’s designed to respond to rises in interest rates. SFHIX also has a low fee of 0.55%. It’s an actively managed fund, and Finfrock likes the two portfolio managers, David Lerner and Jeffrey Gallo. “They’ve been doing really, really good,” he says. The portfolio has very low effective duration of three months, lower than the category average, and holds a mix of BB and B-rated securities.
VanEck Vectors Fallen Angel High Yield Bond ETF (ANGL)
High-yield debt is known as “junk” for a reason. These are below investment-grade holdings that produce higher yield, but with higher risk. ANGL is a lower-risk way to invest in the space as it’s a market-value-weighted index of bonds that once were investment grade but were downgraded to junk. “The term ‘fallen angels’ means they believe that this is an industry that has been affected (negatively), but has a great rebound potential,” Finfrock says, explaining why he likes this fund. The strategy seeks to buy downgraded issues on the idea that future credit upgrades will mean price appreciation. The fund has about $5 billion in assets under management and its total return year to date is nearly 3%.
Vanguard Total International Bond ETF (BNDX)
Many investors still tend to overlook international markets when it comes to asset allocation, particularly in bonds, Bennyhoff says. BNDX offers all the same characteristics as most Vanguard funds — it’s passively managed, diversified and low-cost — but it buys non-U.S. denominated investment-grade bonds. He says the market capitalization of the international bond market is one and one-half to two times larger than the U.S. investment-grade bond market. “Non-U.S. bonds are an extremely large part of the global asset class. And many, many people just don’t have any positions so that helps to kind of capitalize on those opportunities there,” he says. The fund holds more than 6,200 bonds and nearly 80% are in the European and Asia Pacific regions.
Ashmore Emerging Markets Short Duration Fund (ESFIX)
ESFIX invests in mostly sovereign, quasi-sovereign and corporate bonds in emerging markets, and it seeks to keep a weighted average duration between one to three years. Finfrock notes historical performance is weak because emerging markets were out of favor for several years, but he says after the U.S. market’s dominance for the past dozen years, international markets may benefit from a shift in leadership. He particularly likes emerging markets for positive demographics such as a younger population and rising incomes. “The Ashmore fund, I think, does a really great job with looking into some unique emerging markets,” he says. For an emerging market fund, ESFIX has a low expense ratio of 0.67%, and it comes with a yield of 5.5%.
Eight bond funds for retirement:
— Vanguard Tax-Exempt Bond ETF (VTEB)
— Invesco National AMT-Free Municipal Bond ETF (PZA)
— Pimco Active Bond ETF (BOND)
— iShares Core 1-5 Year USD Bond ETF (ISTB)
— Shenkman Capital Floating Rate High Income Fund (SFHIX)
— VanEck Vectors Fallen Angel High Yield Bond ETF (ANGL)
— Vanguard Total International Bond ETF (BNDX)
— Ashmore Emerging Markets Short Duration Fund (ESFIX)
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Update 07/16/21: This story was published at an earlier date and has been updated with new information.