Fixed-income investments can provide long-term cash flow.
The action of the U.S. Federal Reserve in raising interest rates to combat soaring inflation brought an end to a 40-year bull market in bonds. Prior to 2022, decades of falling interest rates dropped bond yields, sending bond prices higher. During numerous market crashes since 2000, the Fed slashed rates to the bone to stimulate markets. At the time, this gave bonds, especially U.S. government Treasurys, a “flight to safety effect,” where they were able to hedge against equity risk thanks to their low correlation. This effect has disappeared in 2022, with bonds losing as much as stocks have. Still, bonds remain important for a diversified portfolio. An allocation to bonds helps reduce volatility and lessens drawdowns. Interest rates won’t remain high forever, so bonds remain important for long-term investors. Here are nine of the best bond exchange-traded funds, or ETFs, to buy in 2022.
Vanguard Total Bond Market ETF (ticker: BND)
Passive investors often hold an allocation of investment-grade bonds suited to their time horizon and risk tolerance. A favorite of “Bogleheads,” or adherents to Jack Bogle’s index investing philosophy, is BND. This ETF holds thousands of investment-grade Treasurys, corporate bonds, mortgage-backed securities and municipal bonds. You can think of BND as a way to “buy a slice of the entire bond market.” The ETF has an intermediate duration of 6.7 years, meaning that if interest rates rise or fall 1%, BND will rise or fall 6.7%. This is a fairly balanced trade-off between interest rate risk and crash protection. Typical of Vanguard funds, BND is very cheap, costing an expense ratio of just 0.03%. That works out to $3 for every $10,000 invested annually.
Vanguard Total International Bond ETF (BNDX)
Investors who diversify their portfolio’s stock allocation internationally can also do the same for their bond allocation by buying BNDX. BNDX tracks the Bloomberg Global Aggregate ex-USD Float Adjusted RIC Capped Index, which holds international investment-grade government and corporate bonds from countries like Canada, the U.K., France, Germany, Australia and Japan. While domestic bonds are great, investing in foreign bonds can sometimes produce better yields and hedge against the remote possibility of the U.S. defaulting on its debt. To mitigate foreign-exchange risk, BNDX is also hedged back to the U.S. dollar using derivatives, as its underlying bonds are denominated in different currencies. The ETF carries a 0.07% expense ratio.
Vanguard Total World Bond ETF (BNDW)
Buying BND and BNDX will give you a complete fixed-income portfolio that covers the world’s investment-grade bond market, but there’s a catch. Investors still need to determine the proportion of each to buy and spend time and commission rebalancing that allocation on a regular basis. A totally hands-off alternative is buying BNDW, which conveniently holds BND and BNDX as its underlying funds. BNDW is essentially a “fund of funds,” allocating around 51% to BND and 49% to BNDX. By buying BNDW, you’re letting Vanguard handle rebalancing and allocating the two ETFs, which can save you time and effort. With just a single ticker, BNDW gives investors a diversified portfolio of high-quality bonds from around the world for an expense ratio of just 0.06%.
iShares U.S. Treasury Bond ETF (GOVT)
Aggregate bond funds like BND, BNDX and BNDW contain allocations to corporate and municipal bond funds. While good for yield, these bonds often have a greater correlation to stocks due to their higher chance of default. Treasury bonds are a lower-risk alternative, as they are debt securities issued and guaranteed by the U.S. government. Buying an ETF like GOVT allows you to track the ICE US Treasury Core Bond Index. During market crashes, Treasurys are often perceived as the safest asset to be in, which can make them a decent hedge against stocks. GOVT has a similar intermediate duration to that of BND, at 6.3 years. The ETF has an expense ratio of 0.05%.
iShares 20+ Year Treasury Bond ETF (TLT)
Long-term bonds are those with 20-plus years until expiration. Due to their longer durations, they have the highest amount of interest rate risk. When rates rise, long-term bonds can lose a lot of value. Conversely, when rates are cut, long-term bonds can rally strongly. Historically, this feature has made them an excellent hedge against market crashes. A great pick here is TLT, which tracks an index of U.S. Treasurys with 20 or more years until maturity and an overall duration of 18 years. If you’re looking to trade options on bonds, TLT is great for that as well, given its strong volume and well-developed options chain. The ETF has an expense ratio of 0.15%.
Vanguard Short-Term Treasury ETF (VGSH)
Investors trying to minimize interest rate risk in their bond allocation can opt for a short-term bond ETF like VGSH, which tracks an index of short-term U.S. Treasurys. This ETF has a duration of just 1.9 years, meaning that if interest rates rise by 1%, VGSH is likely to lose around 1.9%, and vice versa if rates fall. This trait makes VGSH great for older, less risk-tolerant investors looking for “ballast” to reduce portfolio volatility. A great example here is Warren Buffett, who directed his estate to invest 10% in short-term Treasurys like VGSH, with the remaining 90% in the S&P 500. VGSH has an expense ratio of 0.04%.
SPDR Bloomberg 1-3 Month T-Bill ETF (BIL)
The safest asset will always be cash. However, holding a cash allocation in your portfolio doesn’t mean stuffing bills under the mattress or in a savings account. A great way to hold cash while still earning income is via BIL, which tracks the Bloomberg 1-3 Month U.S. Treasury Bill Index. This index holds AAA-rated U.S. Treasurys with less than three months until expiration, making it as “risk free” as investments get. With a duration of just 0.16 year, BIL is well immunized against interest rate risk, and would lose just 0.16% if interest rates rose by 1%. However, the ETF might not beat inflation due to its lower “yield to maturity,” or the percentage return if an investor holds until maturity, compared with longer-duration bonds. BIL has an expense ratio of 0.13%.
Schwab U.S. TIPS ETF (SCHP)
With inflation soaring 9.1% in June from a year earlier, many investors sought protection in their portfolios against its adverse effects. With purchases of I bonds restricted to $10,000 annually, an allocation to Treasury inflation-protected securities, or TIPS, could be a reasonable alternative for some investors. TIPS are issued by the U.S. government and have an AAA credit rating. More important, their price, and therefore their coupon payments, is indexed to inflation. This gives TIPS protection against sudden, unexpected increases in inflation as measured by the consumer price index. Investors can buy a portfolio of TIPS via SCHP, which has an intermediate duration of 6.9 years and a low expense ratio of 0.04%.
SPDR Bloomberg High Yield Bond ETF (JNK)
Yield-hungry investors who don’t mind taking on additional risk can maximize the return potential of their bond allocation by buying JNK. This ETF holds a portfolio of high-yield corporate bonds, otherwise known as “junk bonds.” These bonds tend to have lower credit ratings and thus pay a higher coupon to compensate investors for the higher default risk. JNK currently has a very high yield to maturity of 8.5%, but this is balanced against its higher correlation with stocks. During market crashes, JNK plummets in price as the creditworthiness of its underlying issuers gets called into question. Nonetheless, JNK can be a good investment for investors seeking above-average income that’s higher than most dividend stocks. The ETF costs an expense ratio of 0.40%.
9 of the best bond ETFs to buy now:
— Vanguard Total Bond Market ETF (BND)
— Vanguard Total International Bond ETF (BNDX)
— Vanguard Total World Bond ETF (BNDW)
— iShares U.S. Treasury Bond ETF (GOVT)
— iShares 20+ Year Treasury Bond ETF (TLT)
— Vanguard Short-Term Treasury ETF (VGSH)
— SPDR Bloomberg 1-3 Month T-Bill ETF (BIL)
— Schwab U.S. TIPS ETF (SCHP)
— SPDR Bloomberg High Yield Bond ETF (JNK)
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Update 09/09/22: This story was published at an earlier date and has been updated with new information.