Best Low Cost Bond Funds

Today we will be outlining what I think are the best low cost bond funds. Because there are so many different types of bond funds, I will be breaking them down by bond exposure.

My personal favorites for the best low cost bond funds are:

Corporate Bond Funds: Vanguard Long-Term Corporate Bond ETF (VCLT) or Vanguard Intermediate-Term Corporate Bond ETF (VCIT)

Aggregate Bond Funds: Vanguard Total Bond Market Index Fund ETF (BND)

Government Bonds: iShares US Treasury Bond ETF (GOVT)

High Yield Bonds: iShares Broad USD High Yield Corporate Bond ETF (USHY)

Let’s break these down!

Table of Contents

What is a Bond ETF?

A bond exchange traded fund, or ETF, is a fund that invests in debt securities. The fund owners then receive a return in the form of interest earned in the fund.

The primary risk associated with a bond ETF is the default of the borrowers. If a borrower can’t pay back the debt, the fund may not be able to collect the full value back. This can erode the value of your ETF.

Why Low Cost Bond Funds?

Low cost bond funds are perfect for investors who want a baseline exposure to debt markets. These funds are passive and just follow indexes. So their investments are more simple in nature and don’t require heavy analysis to identify.

This doesn’t meant that low cost bond funds will outperform active funds. In fact, there is quite a debate as to which is better.

But the simple fact remains – low cost bond index funds will charge you far less and give you a very similar exposure to debt markets.

Different Bond Fund Styles

When comparing funds, the risk-reward profile of bonds and bond funds depend on two primary variables:

Credit Risk – the risk of the borrower defaulting.
Interest Rate / Term Risk – the longer the bond, the higher the interest rate (generally) due to the risk of interest rate changes.

Using combinations of the above, you can increase your risk-reward profile, or lower it. For example, mixing high credit risk bonds with low terms could be similar to a low credit risk, high term risk, fund.

For the most popular bond fund types, I’ve outlined my personal favorites below.

Corporate Bond Funds

Vanguard Long-Term Corporate Bond ETF (VCLT)

Net Assets: 6.83bn

Net Expense Ratio: 0.04%

Dividend Yield TTM: 4.79%

VCLT invests primarily in investment grade (less risky) bonds issued by corporations. These bonds have longer terms, so they carry higher term risk. This increases your return over a shorter term bond fund, but still gives you a higher yield due to the length of the loans.

VCLT is an excellent fund for investors looking for lower-risk corporate debt, but are holding for longer periods. VCLT’s weighted average maturity of debt (how long before debt needs to be paid off) is around 22 years.

Remember, the longer your holding period is, the less term risk matters.

This fund is better for an investor with a longer holding period and is okay with more credit risk.

Vanguard Intermediate-Term Corporate Bond ETF (VCIT)

Net Assets: 45.04bn

Net Expense Ratio: 0.04%

Dividend Yield TTM: 3.76%

VCIT is the exact same concept as VCLT, but it holds shorter maturity bonds. VCIT’s weighted average bond maturity is around 7 years, much shorter than VCLT’s 22 years.

As you see, with VCIT you are sacrificing some yield, but in return you are lowering your term risk.

This fund is better for an investor with a shorter holding period and is okay with more credit risk.

Aggregate Bond Funds

Vanguard Total Bond Market Index Fund ETF (BND)

Net Assets: 104.82bn

Net Expense Ratio: 0.03%

Dividend Yield TTM: 3.08%

If you have no idea what class of bonds you want exposure to, look no further. BND invests in ALL types of bonds based on their respective size in the market. This includes government bonds, corporate, and other asset back bonds such as mortgage bonds.

BND only invests in investment grade bonds, which means it ignores riskier “high-yield” bonds.

BND does not have a strict “term” mandate as it’s based on relative size. But in actuality, the weighted average terms of BND’s debt holdings is around 8 years.

Because of its holdings, it is similar to VCIT in terms of maturities, but less risky in terms of credit risk. This is primarily due to its government bond holdings. This brings a slightly lower yield than VCIT.

So for those who want exposure to all types of bonds, BND is great for you.

Government Bonds:

iShares US Treasury Bond ETF (GOVT)

Net Assets: 22.64bn

Net Expense Ratio: 0.05%

Dividend Yield TTM: 2.69%

GOVT is exactly what it sounds like, it invests only in US treasury bonds. GOVT invests in treasuries across a wide array of maturities, with its weighted average maturity being around 8 years.

These bonds are generally considered “credit risk free” given that their borrower is the US Government. Take that as you will, but they are priced as such.

GOVT is great for an investor looking for an extremely safe investment and isn’t as concerned with its yield.

High Yield Bonds

iShares Broad USD High Yield Corporate Bond ETF (USHY)

Net Assets: 12.10bn

Net Expense Ratio: 0.08%

Dividend Yield TTM: 6.64%

Last up, we have the riskiest of all (by far) high yield bond funds! These funds only invest in debt that is below “investment grade” meaning that the companies are much riskier. This means your credit risk is very high as there is a higher change of default on the loans.

In return, you are compensated with an unmatched yield on your investment. This compensates you for all of the risk you’re taking!

USHY is the way to go in my opinion in terms of high yield bond funds. Its expense ratio is a rare 0.08% for this style of fund. This makes it tempting for an investor who just wants exposure to the space, not a complicated product.

Maturity wise, USHY invests in shorter term loans, with a weighted average maturity of about 4.5 years.

USHY is great for an investor looking for much higher returns and isn’t as worried about credit risk.

Bottom Line

You should now know the major types of bond funds, and also the different risks they have. My personal favorites for the best low cost bond funds are: