7 Best Bond Funds for Retirement

Bonds make up the foundation of any successful retirement portfolio. These assets are debt-related instruments issued by governments and corporations that are looking to raise money. Think of them as the other side of the loan, where the “issuer” is the borrower and investors are collectively the lender.

Like any loan, bonds carry interest payments in addition to repayment of the principal amount — meaning this asset can provide a steady stream of cash back to investors. This makes them incredibly appealing, particularly for older investors looking for income to replace their paychecks once they stop working. They also tend to be much less volatile than stocks, making bonds ideal for capital preservation in retirement.

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Unfortunately, building a diversified portfolio of individual bonds can be a complicated and opaque process. But thankfully, bond funds have democratized access to fixed-income markets by allowing even small-time investors to put as little as $100 behind the big-ticket loans to the U.S. Treasury department and leading banks, manufacturers and tech companies.

Not all bond funds are the same, however, and while they are easy to buy, they are also easy for retirement investors to misunderstand. Here’s a brief rundown of some of the top bond investments out there, including both mutual funds and exchange-traded funds, or ETFs, and what they have to offer:

— Difference between ETFs and mutual funds.

— The biggest.

— The “best” right now.

— Find the best bond fund for your investment strategy.

The Difference Between ETFs and Mutual Funds

The list of top bond funds differentiates between mutual funds and ETFs. But you may be wondering: “What’s the difference?”

The short answer is “not much.” Both ETFs and mutual funds are diversified baskets of assets, meaning investors can own a single investment instead of building a complicated portfolio of 1,000 stocks or 1,000 bonds. Keep in mind that both types charge a small fee for that service.

The main difference is that for mutual funds, all buying and selling happens once per day at a fixed price, while ETFs are bought and sold across the entire trading day. ETFs also tend to be a bit cheaper thanks to their recordkeeping and tax efficiency, and they often allow you to buy in for as little as $30 whereas many mutual funds require a minimum of $3,000. But for retirement investors who have decent nest eggs, these differences are far less important than making sure your bond fund or ETF meets your personal investing strategy.

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The Biggest: Vanguard Total Bond Market ETF (ticker: BND)

The largest bond fund is available as both an ETF and a mutual fund. That would be the duo of the Vanguard Total Bond Market ETF (BND) and the Vanguard Total Bond Market Index Fund Admiral Shares Mutual Fund (VBTLX).

Though the tickers and vehicle differs slightly, the strategy is the same, with these funds offering exposure to a mammoth portfolio of more than 17,000 different “investment grade” bonds from U.S. government and corporate borrowers. This includes about 50% of assets in government bonds from the Department of the Treasury and others, about 25% in bonds from government-backed mortgage lenders like Fannie Mae and Freddie Mac, and 25% in top-rated corporations such as Amazon.com Inc. (AMZN) and American Express Co. (AXP). It’s not terribly sophisticated, but for investors who want a bit of the entire bond market, this fund is the way to go.

With a broadly diversified portfolio and a focus on the most creditworthy borrowers, this bond fund is as rock solid as they come. The current yield is 2.4%, meaning you’ll get paid back that portion of your initial investment over the next 12 months — even if the principal value remains unchanged.

As an illustration of the difference between bond ETFs and bond mutual funds, consider that the Vanguard Total Bond Market ETF charges 0.03% in annual expenses and is currently priced at under $80 for a single share while the Vanguard Total Bond Market Index Fund Admiral Shares Mutual Fund charges 0.05% in annual expenses and has an investment minimum of $3,000.

If you have $3,000 to invest, you can buy either — and while the ETF’s fees are smaller, the 0.02 percentage point difference adds up to savings of 60 cents per year.

The “Best” Right Now: Fidelity Conservative Income Bond Fund (FCONX)

Of course, it’s worth noting that in a changing interest rate environment it has been very challenging for many bond funds. That’s because when rates go up, bond funds often lose value because the newer and higher-yielding assets are more attractive to investors than the older bonds these funds hold.

Case in point: VBTLX lost 14% in 2022 — better than the roughly 20% decline for the S&P 500 and offset a bit by the yield, but still a loss.

Meanwhile, the Fidelity Conservative Income Bond Fund actually posted a small gain in an otherwise disastrous year for most other investments, despite having an incredibly low risk profile. You only get a payout of about 2%, but the tradeoff is gaining peace of mind in exchange for a bigger yield.

It’s success is in part because the fund is very targeted, with a portfolio of less than 200 total bonds, and it runs at a much shorter “duration” than its peers. The strategy allows FCONX to buy into very short-term bond investments then roll them off quickly before they can decline or before newer debt issuances steal the spotlight.

The catch? Well, it’s a hair more expensive at 0.35% in annual expenses — or $35 a year on every $10,000 you invest. That’s still not enough to break the bank, however, so it’s definitely worth a look. The fund also has no investment minimums and no transaction fees, making it accessible for even small-time retirement investors.

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Find the Best Bond Fund for Your Investment Strategy

Of course, there’s a great big world of bond funds and ETFs out there. You don’t have to buy everything with a total bond fund like Vanguard’s, nor do you have to be super selective like the Fidelity fund. Whatever your personal tastes or risk tolerances are, there’s sure to be an option that fits you and your retirement investing needs.

Here are a few other representative examples of what’s out there.

Vanguard Long-Term Corporate Bond ETF (VCLT)

It’s generally true that if you want higher yield, you have to take on a bit more risk. The Vanguard Long-Term Corporate Bond ETF is interesting because it offers a bigger payday by excluding rock-solid Treasury bonds. VCLT focuses on only “investment grade” debt from time-tested companies such as investment giant Goldman Sachs Group Inc. (GS), beverage maker Anheuser-Busch InBev SA/NV (BUD) and drugstore giant CVS Health Corp. (CVS). The current yield is 4.1%.

iShares iBoxx $ High Yield Corporate Bond ETF (HYG)

If you don’t mind being a bit more aggressive with your investments, then “junk” bonds could be worth a look. These are debts that get low marks from credit rating agencies because of the risk of a borrower never paying back the full amount. The iShares iBoxx $ High Yield Corporate Bond ETF invests only in these distressed debts, with more than 1,200 holdings, including some shakier corporations such as casino operator Caesars Entertainment Inc. (CZR) and satellite cable provider Dish Network Corp. (DISH). If the economy sours or a few borrowers default, you could be in for trouble with HYG. But the current yield is 5.1% in exchange for this riskier approach.

iShares 1-3 Year Treasury Bond ETF (SHY)

On the opposite side of the risk-reward spectrum is the iShares 1-3 Year Treasury Bond ETF. This is the largest bond ETF in its category with about $28 billion in assets under management. SHY holds a small list of about 75 Treasury bonds, but the average duration is less than two years, so they turn over quickly to avoid exposure to interest rate risks. They also are bonds backed by Uncle Sam and the U.S. Treasury, so they are as sure a thing as you’ll find on Wall Street. Interestingly, the fund has a 30-day yield of 4.4% thanks to recent rises in rates — but even if that rolls back in the long run, the rock-solid approach of SHY makes it a compelling choice for conservative portfolios.

iShares TIPS Bond ETF (TIP)

Speaking of conservative portfolios, an increasingly popular tool to hedge the risk of inflation in these challenging times are Treasury inflation-protected securities, or TIPS. These unique bonds have a direct tie to the rate of inflation as measured by the consumer price index. Considering the metric rose at a red-hot rate of 9.1% in its June reading — the highest level since the 1980s — you can easily understand the power of connecting your bonds to this index of inflation. Over the last 12 months, this fund has averaged a yield of 6.8%. Of course, if inflation crashes then the yield will crater, too. But if your strategy is to offset inflation rather than to latch on to the highest yields, TIP may be worth a look.

Pimco Total Return Fund (PTTAX)

It’s hard to talk about bond funds without acknowledging this iconic offering from Pimco that has long been seen as one of the leading bond funds in the world. The yield at Pimco Total Return Fund doesn’t blow the doors off at 3.9%, but what this fund does provide is tactical and active management that’s meant to keep you ahead of the curve. PTTAX has a mandate to go anywhere and everywhere for the best bonds, including international corporations and governments of all flavors. For instance, the current lineup of about 7,400 positions includes a smattering of emerging market debts and “junk” bonds.

While a bit pricier in annual fees than the other funds on this list, it’s still relatively affordable at 0.80% in annual expenses. And considering that $10,000 invested back at the fund’s inception in 1987 would have grown to almost $80,000 at present while outperforming its peers along the way, the extra fees may be worth it for those looking for a more active hand to guide their bond fund.

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7 Best Bond Funds for Retirement originally appeared on usnews.com

Update 02/23/23: This story was previously published at an earlier date and has been updated with new information.

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