Interest rate hikes have pushed bond yields to attractive levels again.
Historically, bonds have always acted as a kind of “ballast” for portfolios. During market crashes like those in 2008 and March 2020, bonds, especially high-quality ones like U.S. government Treasurys, soared in a “flight to safety.” This was due to the Federal Reserve slashing interest rates and implementing quantitative easing, which boosted the price of fixed-income assets. Although this changed in 2022 when interest rates rose sharply and caused bonds to sell off alongside equities, 2023 might be shaping up to be a better year for bonds. This is because bond yields have started the year at a much higher level. This can potentially help bonds become a viable income-generating asset once again. To get around the lack of liquidity and complication of buying individual bond issues, consider using a low-cost bond exchange-traded fund, or ETF. Here are the nine best bond ETFs to buy right now.
Vanguard Total Bond Market ETF (ticker: BND)
A popular low-cost buy-and-hold fund for long-term investors is BND, which offers broad exposure to the U.S. bond market. By tracking the Spliced Bloomberg U.S. Aggregate Float Adjusted Index, BND provides access to over 10,000 government, agency and investment-grade corporate bonds. The ETF currently provides a weighted-average yield to maturity, or the interest an investor earns when holding the bond until it matures, of 4.3% along with an intermediate average duration of 6.6 years. Should interest rates rise by 1%, BND can be expected to lose 6.6% in value, all else being equal. The opposite will occur if rates are cut. Bond price and yield move inversely: when one goes up, the other goes down. BND’s most notable feature is its low expense ratio of 0.03%, or about $3 annually per $10,000 invested.
iShares Core US Aggregate Bond ETF (AGG)
A popular alternative to BND is AGG. This ETF tracks the Bloomberg US Aggregate Bond Index, which is often used as the benchmark of U.S. bond market performance. AGG is very popular and liquid, possessing high assets under management, or AUM, of $85 billion along with a 30-day average volume of over 7 million shares. The ETF is similar to BND, also holding over 10,000 government, agency and investment-grade corporate bonds. AGG has a yield to maturity of 4.7% and a duration of 6.3 years. It charges a low expense ratio of 0.03%.
The US Treasury 2 Year Note ETF (UTWO)
UTWO is a single-bond ETF, a unique and new type of investment product. As its name suggests, UTWO’s sole portfolio holding consists of the current U.S. 2-year Treasury note. This stands in contrast to other bond ETFs, which hold a “ladder” of different issuers and maturities. For investors and traders looking to target a specific yield-curve play, UTWO offers more precise exposure than most bond ETFs. UTWO’s ETF structure also allows investors to gain Treasury exposure in a transparent and liquid way without buying directly on government websites. UTWO currently charges a 0.15% expense ratio and has attracted $273.4 million in AUM.
iShares U.S. Treasury Bond ETF (GOVT)
The “flight to safety” effect noted at the start of this article tends to be most pronounced for U.S. Treasurys. This is due to their much lower credit risk when compared to corporate bonds. Virtually all Treasurys are rated AAA by Standard & Poor’s, signifying that they have a low probability of default. Investors who buy Treasurys are banking on the assumption that the U.S. government will always make good on its debts, which has historically been the case. A great way of accessing a broad portfolio of Treasurys is via GOVT, which currently has a yield to maturity of 4.3% along with a 6.1-year duration. GOVT costs a 0.05% expense ratio.
iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD)
On the other hand, investors who don’t mind taking on higher credit risk in exchange for stronger yields can opt for ETFs that hold investment-grade corporate bonds. These are bonds issued by companies. To be considered investment grade, the bonds must have credit ratings of at least BBB from S&P. LQD tracks over 2,500 corporate bonds in one investment. Compared to GOVT, LQD has a higher yield to maturity and duration of 5.4% and 8.4 years, respectively. A quarter of its bonds come from companies in the banking sector, and 47% of the fund’s holdings are rated BBB, while 42% are rated A. LQD charges a 0.14% expense ratio.
SPDR Bloomberg High Yield Bond ETF (JNK)
Investors willing to take on even more credit risk for the highest possible yields can opt for below-investment-grade bonds rated lower than BBB. These are called high-yield, or “junk,” bonds. Compared to Treasurys and investment-grade corporate bonds, high-yield bonds tend to be more correlated with the stock market and sensitive to its movements. Their higher credit risk implies a higher risk of default, but investors willing to take on that risk tend to be rewarded with higher yields on average. A case in point is JNK, which despite having a short duration of 3.9 years, pays a high yield to maturity of 8.7%. JNK currently charges a 0.4% expense ratio.
Schwab US TIPS ETF (SCHP)
One of the main weaknesses of bond ETFs is inflation. When goods and services prices soar, central banks tend to respond with interest rate hikes, which negatively impact bond prices. Treasury inflation-protected securities, or TIPS, are a type of bond somewhat resistant to these conditions as their price and coupon payments are indexed to the consumer price index. While they’re not immune, TIPS can offer greater protection than bonds if inflation suddenly spikes. To access a portfolio of broad TIPS, investors can buy SCHP, which currently has a duration of 6.6 years and a yield to maturity of 4.03%. SCHP charges a 0.04% expense ratio.
SPDR Bloomberg 1-3 Month T-Bill ETF (BIL)
The safest type of bond is the U.S. Treasury bill, or T-bill. These are ultrashort fixed-income securities issued by the U.S. government with maturities of a year or less. As a result, they carry low interest rates and default risk. To access T-bills, investors can buy BIL, which tracks the Bloomberg 1-3 Month U.S. Treasury Bill Index. BIL has a short duration, which insulates it from interest rate movements. Thanks to the current inverted yield curve, Treasurys with shorter maturities are yielding more than longer-dated ones. Case in point, BIL currently pays a yield to maturity of 4.6%, higher than longer-duration Treasury ETFs like GOVT. BIL charges a 0.14% expense ratio.
Vanguard Tax-Exempt Bond ETF (VTEB)
Investors in a higher income tax bracket may find most bond ETFs to be tax inefficient when held outside of a tax-advantaged account like a Roth IRA. Municipal bonds, which are issued by local governments to fund infrastructure projects like bridges, roads and waterworks, offer a potential solution. The income from these bonds is exempted from federal and state taxes in certain circumstances. With VTEB, investors can access over 6,900 municipal bonds from across the U.S. This ETF has a high credit rating, with 21% in AAA and 56.8% in AA-rated municipal bonds. Currently, VTEB sports a duration of 5.4 years, a yield to maturity of 3% and an expense ratio of 0.05%.
9 of the best bond ETFs to buy now:
— Vanguard Total Bond Market ETF (BND)
— iShares Core US Aggregate Bond ETF (AGG)
— The US Treasury 2 Year Note ETF (UTWO)
— iShares U.S. Treasury Bond ETF (GOVT)
— iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD)
— SPDR Bloomberg High Yield Bond ETF (JNK)
— Schwab US TIPS ETF (SCHP)
— SPDR Bloomberg 1-3 Month T-Bill ETF (BIL)
— Vanguard Tax-Exempt Bond ETF (VTEB)
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9 of the Best Bond ETFs to Buy Now originally appeared on usnews.com
Update 02/27/23: This story was previously published at an earlier date and has been updated with new information.