How to choose the Best US Bond ETF

HOW to choose the best US BOND ETF?

Annual Yield for key Bond ETFs vs. Expected Inflation

As of 15th July 2021. Current Yield to Maturity for different Bond ETF Categories and Time Horizons. Inflation is annualized over the period. The longer the horizon the higher the return. However, Intermediate High Yield is riskier than Long Term Investment Grade Corporate Bonds. Source: Bloomberg,

Key Selection Criteria

Depending on whether you are saving for retirement or have retired already certain Bond ETFs may be more suitable than others.

Treasuries stabilize your portfolio. Once retired, you may think of earning additional income from Corporates.

Bond ETFs should match your time horizon and fit into your wider portfolio.

#1 Be Smart about Yield

Before you dive deeper into the yields in the tables below, remember that:

  • Comparing yields can be tricky  each provider can have its own calculation methodology and there are numerous ways of defining yield. Fortunately, the tables below are consistent and sourced from Bloomberg giving you a fair comparison of the Funds.
  • All Yields to Maturity in this Guide are before inflation
  • The only exception are Inflation Protection Bond ETFs (TIPS) that have a yield in the table after inflation (i.e. Real Yields). Therefore, if you want to compare Treasury Bond ETFs with TIPS you need to subtract inflation from the Yield to Maturity. In real terms (Real Yields) returns from both of them will be similar
  • Municipal Bond ETFs may be exempt from certain taxes (e.g. Federal) hence the yield/dividends should be compared to yields post tax from other categories 

#2 Think about Inflation

Before any Bond ETF analysis below don’t forget to have a quick look at expected Inflation.

Always compare expected ETF Yield to (broadly) the same horizon of expected Inflation.

By subtracting inflation from the Nominal Yield in the below ETF tables, you will understand what is the real return you can expect accounting for changes in consumer prices.

E.g. For the Intermediate Bond Category, you can take Medium-Term Inflation etc.

Below are the current expected annual inflation rates for different investment horizons: 

#3 Choose between Cash and Bond ETFs

Certain bonds have currently negative real yield and you may be wondering – why bother at all? 

One option that is always on the table, before even considering the below funds is keeping your cash.

How much can I gain/lose by holding Bonds ETFs vs. Cash?

Or if rates rise, are Bond ETF losses temporary? If so, when will coupons offset any price losses for my Bond ETF?

I have a dedicated article with a Bond ETF Calculator that answers these questions and how to help you decide between Bond ETFs vs. Cash (or having both) in a low yield environment.

#4 Pick the Time Horizon

It is considered good practice to match your time horizon (Short Term, Intermediate or, Long term) with the appropriate Fund Maturity Profile.  

The Bond ETFs below are sorted by Term that you should match with your investment horizon:

  • Short Term Bond ETFs (up to 3-year duration)
  • Intermediate Bond ETFs (3 to 10-year duration)
  • Long Term Bond ETFs (usually with duration over 10 years)

#5 Evaluate Safety vs. Income Trade-off

Saving for Retirement or Decumulation

If you are in  an accumulation phase and saving for retirement and looking for Bonds to hedge your Equity portfolio the best choices are Aggregate Bond or Treasury Bond ETFs as well as TIPS.

Read more about how these Bond ETFs can work as part of a wider portfolio. 

If you are in a decumulation phase and have already retired, you may consider replacing some risk assets with some low risk income through Corporate Bond ETFs or may in some cases contemplate, depending on your risk tolerance, the rest of your portfolio, and tax situation some niche ETF markets like High Yield Bond ETFs or Munis.

Aggregate Bond Funds

Also called Core or Blended Bond ETFs. The first group is a broad category consisting of a mix of  Treasuries, High-Quality Corporates, and Mortgage Bonds, all usually rated Investment Grade. 

Importantly, these ETFs are the easiest to invest in since they include most of the high quality bond universe.


US Treasury Bond Funds

The second group consists of Treasury Bonds that are considered virtually risk-free (no Default Risk). However, yields are currently very low and after accounting for inflation even negative for short term / intermediate Bond ETFs.


High-Quality Corporate Bond Funds 

The third group consists of bonds called Investment grade bonds – considered relatively safe because the resources of the issuers are sufficient to indicate a good capacity to repay obligations (usually issued by Blue-Chip Companies)

When you review the below tables keep in mind that conceptually the higher the “Spread” the higher the Credit Risk (although Spreads tend to also increase with time horizon, more about this here


High Yield Bond Funds

The highest yielding bonds are also known as speculative. Importantly, all Corporate Bonds face Default Risk. However, Speculative-grade bonds are issued by companies perceived to have a lower level of credit quality compared to more highly rated investment-grade companies (Read More on Credit Ratings)


Inflation Protection ETFs and Municipal Bond ETFs

Inflation Protection Treasury Bond ETFs (also known as TIPS) and Municipal Bond ETFs (also known as Muni ETFs) have their specific characteristics.

Inflation Protection ETFs are as safe as Treasuries and will generate Real Rates of return (which are currently negative) but protect you should inflation pick up (the yield is the sum of the one you see in the table below and inflation since their cash flows are adjusted for inflation).

Municipal Bonds are financing local governments and may have higher Yield than Treasuries (but also more risk) and potentially preferential Tax treatments.

#6 Consider Size

Why is the size of an ETF important?

If you have invested in ETFs you may have witnessed closure of a Fund because commercially it wasn’t profitable. It’s not a problem for liquid markets but Bonds typically aren’t and small funds:

  • Are linked with the risk of closing down
  • When they close down there is a risk the liquidation won’t be executed at the best prices

Note that most of the ETFs below have a minimum size anyway and are considered benchmarks by market participants (I’ve not considered ETFs below $1bn AUM with a couple of exceptions)

Largest Funds in each category

#7 Understand Bond Risk and Return

Bond ETF Calculator Run your scenario in JPOW Calc and test how rising rates may affect your Government Bond (and to a great extent Aggregate Bond) ETF

  • Assets are a measure of the Size of the Index Fund Fund. I generally only list Index funds with a minimum size of $1bn that are widely used by Investment Professionals. The exceptions are Niche Funds (Category 4) which are smaller by definition
  • Expense Ratio – keep it low to generate more return. In order to do that plug two expense ratio numbers for comparison in the ETF Fee Calculator to see how it impacts your returns over the long term
  • Duration is a measure of Interest Risk for Bonds (more on Interest Rate Risk). 
    A rule of thumb is to align the average maturity of a bond ETF with the length of time that you’ll have your money invested in that ETF. Also, that the longer the duration the more you can gain or lose from moving interest rates (for Treasuries, it will also provide a more effective diversification for Equities since rates tend to fall in a downturn)
  • Spread is a measure of Credit Risk for Corporate Bonds (more on Credit Risk). Broadly speaking it is the additional return (in basis points 100 bps = 1%) over US Treasuries. Therefore, the higher it is the riskier the Bonds
  • Yield to Maturity – is what you can expect the Bond ETF to generate going forward (conceptually it is the sum of  Treasury Bond Yield and Spread) but before taking into account inflation
  • Dividend Yield – shows how much was generated over the past 12 months. It can also include Capital Gain. However, past dividend yield is not necessairly an indication of future dividends (Example for Treasuries described here)
  • Year to Date Return – Bond ETF price move year to date. Moves in an opposite way to changes in interest rates and spread
  • Maximum Drawdown – is the maximum historical Bond ETF price decline from the peak. As you can see it is in line with a combination of either or both duration / spread that are the key risk metrics for Bonds. However, this should not be seen in isolation but rather how the drawdowns behave combined in a portfolio with Equities



Best Bond ETFs by Relative Size

One of the Best Bond ETFs is iShares Core Total USD Bond Market ETF (IUSB)

  • The fund is fairly safe with 65% of Bonds in the highest rating category (AAA)
  • The ETF is generating one of the highest yields in its category in this low yield environment 
  • Outside of Government Bonds and Mortgage-backed Securities from government-backed entities like Fannie Mae and Freddie Mac the incremental Yield comes from a handful of Financial Institutions like Morgan Stanley, or Industrials like Oracle, Verizon or Dell
  • This ETF should provide a good diversification for your Equity portfolio while still generating yield

Aggregate Bond ETF Category - Best Bond ETF List

Below are some of the Best Fixed Income ETFs in 2021 as regarded by Market Participants in Category “Aggregate Bond ETFs”:

Aggregate Category - Best Bond ETFs Links


Best Treasury Bond ETFs - Relative Size

One of the Best Bond ETFs is iShares US Treasury Bond ETF (GOVT)
  • Firstly, this fund provides the best Yield in the Intermediate category
  • Secondly, Treasuries are the safest investment that benefits from flight to quality should the market deteriorate (yes, yields can go even lower from here which would boost this fund)
  • However, after accounting for Inflation like most of the below Funds, GOVT ETF yields negative Real Return e.g. Annual Yield is 1.5% while 7 Year Inflation Rate is 2.5%
  • Also, there is also a risk of under-performance should Inflation come back
  • In conclusion, this is why I marginally prefer the Aggregate Funds (Category #1) 

Read more about risks and returns you can expect from US Treasury Bonds in 2020

Treasury Bond ETF Category - Best Bond ETF List​

Below are some of the Best Fixed Income Index Funds in 2020 as regarded by Market Participants in Category “Treasury Bond ETFs”:

Click to enlarge

Treasuries - Best Bond ETFs Links​


Best Bond ETFs by relative Size

One of the Best Bond ETFs is iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD)
  • Great Brand: LQD is perhaps the most recognizable name in Corporate ETF space and was the #1 on FED SMCCF Purchase List in absolute amount
  • Longest Track Record: Established in July 2002, it has the longest track record of all the reviewed Funds
  • Liquid and diversified: Very liquid and diversified across over 2,200 Bonds
  • High Yield: With a longer-term and marginally more aggressive profile the spread is higher at 133 bps which explains most of the difference in Yield (2.7% before inflation) vs. Vanguard VCIT 
  • Strong Sponsor: BlackRock provides better transparency of holdings and analytics
  • FED Quality stamp: Below are the bonds that were heavily bought by the FED, before it started winding down the COVID-19 related program.
SMCCF FED ETF purchase programme - quantitative easing trading history LQD VCIT VCSH VCLT
FED Corporate Bond ETF Purchases - Click on the chart to read the review of the Funds

Corporate Bond ETF Category - Best Bond ETF List

Below are some of the Best Fixed Income Index Funds in 2021 as regarded by Market Participants in Category “Investment Grade ETFs”. If you want to understand how the Spread (Credit Risk) for Investment Grade Bond Universe has evolved over time check FED data.

Click to enlarge

Corporate Category - Best Bond ETFs Links


Best Bond ETFs by relative Size

One of the Best Bond ETFs is SPDR Bloomberg Barclays High Yield Bond ETF (JNK)
  • JNK has a High Risk / Reward investment with substantial Credit Risk e.g. over 10% is in Energy Sector alone with other risky sectors like Aircraft part manufacturers
  • The fund is well-diversified with over 900 Bonds
  • Interest Risk is relatively lower than other categories because the Bonds are floating (not fixed) 
  • The FED was buying JNK ETF as part of its ETF Purchase Program (SMCCF)
  • However, close to 15% of the Fund is Rated CCC or lower with high Default Risk (see chart below that indicates risk before taking into account Coronavirus Market)

Before you consider High Yield...

  • This is the riskiest part (high risk / high returns) of the mainstream ETF Bond Universe (you can observe how the Spreads are much wider than the Investment Grade category). 
  • Remember, it is not unusual to see Bonds defaulting within these Funds. As such they tend to underperform during a downturn (similar to Equities, hence lower diversification benefit)
  • The ETFs have a very high correlation to Equities providing very poor diversification
Defaults are frequent - On the graph below High Yield is represented by (BB & B & CCC/C)
High Yield starts below BBB- while defaults are usually below 5% for Investment Grade. Source: S&P Global Fixed Income Research

High Yield Bond ETF Category - Best Bond ETF List

Click to enlarge

High Yield Category - Best Bond ETFs Links


TIPS Characteristics

What is the difference between Treasuries and TIPS if real rates on them are roughly the same?

The real yield may be the same but they won’t react the same way to inflation / deflation. TIPS will protect you against inflation but will under-perform if inflation turns out lower than expected.

For Inflation-Protected Bonds, both Bond Face Value and coupon are adjusted to inflation so you get inflation protection. The downside is limited since you always get par price back. However, since inflation is much more common over longer time periods Bond’s face value would have gone up since issuance. This means that should price levels drop the face value will be reduced up to the floor level. If inflation drops more than expected Treasuries will outperform TIPS

In the below tables, the Yields are Real i.e. you need to add inflation to get the nominal yield that you will get from these Bonds (it’s just a market convention)

Inflation Protection Category - Best Bond ETF List

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TIPS - Best Bond ETFs Links


Muni Characteristics

Muni bond ETFs are exempt from federal income tax but may be subject to an investor’s state and local income taxes. Muni Bond ETFs are especially advantageous for high earners with the highest tax rates. Given their increased risk profile these tend also to yield more than Treasuries. 

Yields tend to correlate with risks e.g. SPDR Nuveen Bloomberg Barclays High Yield Municipal Bond ETF (HYMD) – last of the list is exposed to local entities rated below Investment Grade. Its top exposures include Puerto Rico (High Yield), Ohio and, California. The Long term funds have a higher interest rate risk as the duration is between 6 and 10 years. 

Municipal Bonds Category - Best Bond ETF List

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Munis - Best Bond ETFs Links


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