These investments pay a return on a fixed schedule.
As 2021 comes to a close, bond funds are showing signs of struggle. The Morningstar Core Bond Index recorded its first decline since 2013 this month. As interest rates begin to rise, things aren’t looking much better for fixed-income investors in 2022. This doesn’t mean, however, that it’s time to purge bonds from your portfolio. It just means investors need to be more strategic in the fixed-income funds they hold. Many financial experts suggest focusing on 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.
Invesco National AMT-Free Municipal Bond ETF (ticker: 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 just under nine years. The fund has higher yields for a municipal bond fund with average credit risk. It has around $2.6 billion in assets under management and a relatively low expense ratio of 0.28%, which is $28 for every $10,000 invested. “With interest rates so low, there’s really not a lot of options available,” Simpson says. But with a trailing 12-month yield of 2.35%, 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 trailing 12-month yield of 1.93% 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 exchange-traded fund 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. “Because the funds are constantly buying and selling different bonds, the interest rates will change as rates change,” he says. “The good thing about that is that as rates start to rise next year, so should the rates that these funds pay out to investors.”
iShares Core Total USD Bond Market ETF (IUSB)
IUSB is ranked the No. 1 intermediate core-plus bond fund by U.S. News. Also a gold-rated fund by Morningstar, as a core-plus fund, IUSB allows its managers to have more flexibility in the bonds they own, allowing them to drift into more diverse areas of the market. In the case of IUSB, it means you get exposure to the entire credit spectrum, but its market-cap weighting keeps the emphasis on the highest-quality bonds. With an expense ratio of only 0.06%, you won’t lose much of your return to fund expenses, either.
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.”
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 portfolios’ asset allocation. Halverson says he uses DFGBX as a way for his clients to make up for this lack of 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-month 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, education director at Vestory by Apella. 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 interest rates. The fund comes with a low annual cost of 0.025% and a trailing 12-month yield of 1.8%.
Vanguard Total Bond Market ETF (BND)
Another fund McDonald recommends is BND, 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 more than 10,000 bonds, nearly 69% of which are rated AAA. 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 0.035% and a trailing 12-month yield of 1.9%. As an ETF, there is also no investment minimum, and with many brokerages offering commission-free trading, you may be able to purchase it for as little as the price of one share. 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,” McDonald says.
Vanguard Inflation-Protected Securities Fund (VIPSX)
With inflation on the rise, you may want a hedge against inflation in your portfolio. The government may insist the current rise in inflation is just temporary, but inflation is still a fact of life long-term investors can’t afford to ignore. Treasury inflation-protected securities, or TIPS, are a great way to add inflation protection to your fixed-income portfolio. TIPS work by adjusting the bond’s principal in line with changes in the consumer price index, or CPI. If inflation and the CPI rise, so does your principal and, by extension, your interest payments. When the bond matures, you get either the adjusted principal or original principal, whichever is greater. The Vanguard Inflation-Protected Securities fund is an easy way to access the inflation protection of these bonds without needing to buy individual bonds directly, and at a 0.2% expense ratio, it’s an inexpensive way to do it, too.
Top fixed-income funds for your portfolio:
— Invesco National AMT-Free Municipal Bond ETF (PZA)
— Vanguard Intermediate-Term Bond ETF (BIV)
— iShares Core Total USD Bond Market ETF (IUSB)
— 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 ETF (BND)
— Vanguard Inflation-Protected Securities (VIPSX)
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Update 12/20/21: This story was previously published at an earlier date and has been updated with new information.