Three Flavors Of Bond ETFs

8/15/2016


Low interest rates have bond investors searching far and wide for steady income. The Forecasts favors short- and intermediate-term bond funds — our favorites are listed in bold below. But fans of index funds and exchange-traded fund (ETFs) should find the 10 low-cost funds below worth a look.

BOND EXCHANGE-TRADED FUNDS WORTH A LOOK
Our recommended bond mutual funds, listed in bold at the bottom of the page, are top picks. Investors willing to branch out a bit should consider the 10 exchange-traded funds (ETFs) listed below. All 10 boost solid track records and low expense ratios.
-- Total Return --
Fund (Price; Ticker)
Est.
Yield
(%)
YTD
(%)
5-Yr.
(Ann.)
(%)
Exp.
Ratio
Category
SPDR Barclays Convertible
($46; CWB)
5.3
8.1
10.2
0.40
Convertibles
Vanguard Mortgage-Backed
($54; VMBS)
1.7
3.1
2.4
0.10
Gov't mortgages
Vanguard Interm.-Term Gov't
($67; VGIT)
1.6
4.6
2.5
0.10
Gov't intermediate
Vanguard Long-Term Gov't
($86; VGLT)
2.3
16.2
7.9
0.10
Gov't long-term

Vanguard Short-Term Gov't ($61; VGSH)

0.7
1.2
0.6
0.10
Gov't short-term
SPDR Barclays TIPS ($58; IPE)
0.8
7.2
1.5
0.15
Inflation protected
SPDR Nuveen High-Yld. Muni.
($59; HYMB)
4.2
6.6
8.6
0.45
Tax-free high-yield
iShares National Muni.
($113; MUB)
2.3
3.6
4.6
0.25
Tax-free intermed.
VanEck Vectors Long Muni.
($21; MLN)
3.0
6.8
6.7
0.24
Tax-free long-term
VanEck Vectors Short Muni.
($18; SMB)
1.1
1.9
1.7
0.20
Tax-free shrt.-term

The ETFs hail from three categories:

Convertible bonds. These bonds may be converted into common stock at a predetermined price. Because of their structure, convertibles generally pay lower rates than similar nonconvertible bonds — but higher rates than the underlying stocks. Importantly, they behave more like stocks when stocks advance, but act more like bonds when stocks retreat. Thus, their risk and return is between that of stocks and bonds. Convertibles are often of low credit quality and trade less often than other bonds, translating to higher risk. Yielding 5.3%, SPDR Barclays Convertible Securities ($46; CWB), which holds 93 securities, has a five-year annualized return of 9.4%. The expense ratio is 0.40%.

Government bonds. Conservative investors should consider the dependable returns of government bond funds because of their zero default risk. Many funds invest in Treasurys — debt issued directly by the U.S. government. Others invest in mortgage securities backed by the government, which offer a higher yield than Treasurys. Government bonds are not risk-free — they still face interest-rate risk, which increases with a bond's time to maturity. Yielding 1.6%, Vanguard Intermediate-Term Government ($67; VGIT) is a good all-weather ETF. The fund charges only 0.10%.

Municipal bonds. Looking to trim your tax bill? Municipal (muni) bonds are exempt from federal and some state and local taxes. Issued by states, cities, and entities like hospitals or utilities, the bonds typically pay lower yields than taxable bonds. However, investors might not save enough on taxes to make up the difference. For example, intermediate-term municipal bond funds yield around 2.3% — the equivalent of a taxable yield of 3.5%, assuming a 35% federal tax bracket.

In contrast, a 15% tax rate puts the taxable equivalent yield at only 2.7%, below the average of 3.1% for taxable corporate bond funds. Muni bonds, considered low risk because of their infrequent defaults, should not be held in nontaxable accounts. Among ETFs, iShares National Muni Bond ($113; MUB) is a standout. Yielding 2.3%, the fund charges only 0.25%, versus a category average of 0.83%.

OUR RECOMMENDED MUTUAL FUNDS
-- Year-To-Date --
Target Weights
Fund (Price; Ticker)
Total
Return
(%)
Rank
Conser-
vative
(%)
Growth
(%)
Fund
Rating
Baird Core Plus Bond ($12; BCOSX)
6.8
A
9
4
96
Dreyfus MidCap Index ($36; PESPX)
12.5
A
0
0
83
Dreyfus Small Cap Stock Index
($28; DISSX)
11.5
A
0
0
95
Fidelity Overseas ($41; FOSFX)
1.4
C
9
9
96
iShares MSCI EAFE Small-Cap ETF
($51; SCZ)
3.0
C
4
6
100
PRIMECAP Odyssey Stock ($25; POSKX)
6.5
C
7
8
56
T. Rowe Price QM U.S. Small-Cap
($27; PRDSX)
6.6
B
4
4
97
Vanguard 500 Index ($202; VFINX)
8.1
B
9
10
84
Vanguard GNMA ($11; VFIIX)
3.3
C
0
0
85
Vanguard Growth Index ($58; VIGRX)
6.6
A
10
11
94
Vanguard High-Yield Corp.
($6; VWEHX)
9.0
D
5
6
98
Vanguard Inter.-Term Tax Exempt
($15; VWITX)
3.7
B
0
0
94
Vanguard Selected Value ($27; VASVX)
6.0
E
7
10
54
Vanguard Short-Term Invest.
Grade
($11; VFSTX)
3.5
A
9
4
99
Vanguard Small Cap Value Index
($27; VISVX)
12.6
B
4
4
98
Vanguard Strategic Small-Cap
($31; VSTCX)
7.8
D
4
4
91
Vanguard Total Bond Mkt. Index
($11; VBMFX)
5.9
C
0
0
75
Vanguard Value Index ($34; VIVAX)
9.0
B
9
10
93
Vanguard Wellesley Income
($26; VWINX)
9.0
A
0
0
99
Vanguard Wellington ($39; VWELX)
7.8
A
10
10
97
* Through Aug. 9. Ranks compare funds with same objectives: A = top 20%; B = next 20%; C= middle 20%; D = next 20%; E = bottom 20%. Fund ratings are percentile ranks, with 100 the best.

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