HOW to choose the best US BOND ETF?
Annual Yield for key Bond ETFs vs. Expected Inflation
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
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- Licence to Yield – Which Bond ETFs for your goals? How do price change? Should you hedge currencies?
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- Licence to Yield – Which Bond ETFs for your goals? How do prices change? Should you hedge currencies?
- Don’t get fooled by Wall Street – ESG Ratings are not designed to protect the planet. Adjusted for risk, ESG ETFs will also inevitably underperform. So how can you invest Sustainably?
#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:
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Beginners often ask us:
- How do I reach my goals – What investments do I need to take into consideration for e.g. Taking a Sabbatical, buying a House or saving for Early Retirement?
- When should I invest – I fear that investing a lump sum in this market may have a negative impact on my returns. How can timing of buying ETFs affect my performance?
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- What should I consider investing in – What are some risks of portfolio diversifiers like Gold or Crypto?
- Avoiding Extra Costs – I have shortlisted a few ETFs, can you help me to compare them before I decide which one to buy?
- Benchmarking – What are educated investors doing in a similar situation to mine?
We are flexible. For example, answering some of these questions could help you avoid very costly mistakes:
- Challenging My Portfolio – Here is my portfolio – what am I missing? What could derail my strategy?
- Accelerating My Understanding – What are inflation linked Bonds? How are they different to Nominal Bond ETFs? What makes them outperform? Why do some investors add small cap value stocks to their portfolios? I want to exclude Tobacco companies from my portfolio – what are my options? What is Factor Investing?
- Simplifying Portfolio Maintenance – How can I diversify my investments? What is historically highly correlated so that I can consider removing it to keep my portfolio simple? How do I perform rebalancing? Does frequency matter?
- Reducing Risks – I want to understand the risks of investments – what are the different measures and how does it impact me? What are the risks of different types of brokerage accounts?
- Understanding the Impact of Recent Events – How do recent events impact my portfolio? What can I do to protect my savings from shocks?
- Investing Goals – I am investing for a specific goal e.g. Early Retirement, what is the research saying about e.g. the amount I need to have accumulated, how much can I withdraw annually? What are some calculators available and how to run them? What are the assumptions/shortcomings of these models?
- Comparing Equivalent ETFs – I have certain constraints in my tax-wrapper and can only select certain funds (e.g. I live in France and limited to specific synthetic ETFs). Which ETF characteristics should I pay attention to?
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Sometimes individual sessions are very helpful to get past your investing concerns. Our readers asked us to create coaching sessions. And we’re proud to say, that some of them even ditched their Financial Advisors, after experiencing the value we provide.
Most coaching participants come from the EU or the UK.
But we have consistent demand from all around the world. We provided coaching sessions to individual investors stretching from Argentina to New Zealand, or Guatemala to Japan.
A significant part of our clients are professionals in the Tech sector, Lawyers or Doctors that want to avoid costly mistakes when investing.
We also coach 25-30 year old young professionals that want to maximise assets for early retirement. We also have a large group of entrepreneurs that e.g. receive large lump sums after selling their company and want to invest it in financial markets. We speak to Crypto millionaires that want to reduce their risks.
Finally, some of our coaching clients are in their 40s or 50s and want to set up customised, income-producing portfolios or create Bond ladders for their retirement.
Most of the coached investors are in the 25–60 year old range.
Yes, some of our coaching clients have shared reviews on Google.
Some considerations are included below. For more details, consult your regulator’s website.
A financial coach is:
- Trained but not regulated
- Skilled at reviewing your overall financial situation and goals
- Able to help you develop a financial plan to achieve those goals
- Happy to discuss the pros and cons of various financial products but can’t recommend a specific one for you
- Comfortable working with anyone, whatever their situation
- Going to charge for their time
A financial adviser is:
- Regulated and authorised by the regulator to recommend specific products to clients or is independent and able to offer ‘whole of market’ solutions
- Often, going to charge an annual management fee, typically 1-2% of their client’s assets with initial fees on top.
We are proud to say that our coaching service has empowered a number of clients to reconsider their financial advisers’ offerings. From our clients’ feedback, in a number of cases, clients were overcharged, and offered unsuitable products, often due to conflicts of interest. However, this is not a rule. The best choice between a financial coach and adviser depends on an individual’s unique circumstances, including their financial literacy, time availability, comfort with managing their finances, and complexity of their financial situation.
Beginners often ask us:
- How do I reach my goals – What investments do I need to take into consideration for e.g. Taking a Sabbatical, buying a House or saving for Early Retirement?
- When should I invest – I fear that investing a lump sum in this market may have a negative impact on my returns. How can timing of buying ETFs affect my performance?
- How do I Invest – What are the pro and cons of investing with a Bank? Why should I diversify brokers?
- What should I consider investing in – What are some risks of portfolio diversifiers like Gold or Crypto?
- Avoiding Extra Costs – I have shortlisted a few ETFs, can you help me to compare them before I decide which one to buy?
- Benchmarking – What are educated investors doing in a similar situation to mine?
We are flexible. For example, answering some of these questions could help you avoid very costly mistakes:
- Challenging My Portfolio – Here is my portfolio – what am I missing? What could derail my strategy?
- Accelerating My Understanding – What are inflation linked Bonds? How are they different to Nominal Bond ETFs? What makes them outperform? Why do some investors add small cap value stocks to their portfolios? I want to exclude Tobacco companies from my portfolio – what are my options? What is Factor Investing?
- Simplifying Portfolio Maintenance – How can I diversify my investments? What is historically highly correlated so that I can consider removing it to keep my portfolio simple? How do I perform rebalancing? Does frequency matter?
- Reducing Risks – I want to understand the risks of investments – what are the different measures and how does it impact me? What are the risks of different types of brokerage accounts?
- Understanding the Impact of Recent Events – How do recent events impact my portfolio? What can I do to protect my savings from shocks?
- Investing Goals – I am investing for a specific goal e.g. Early Retirement, what is the research saying about e.g. the amount I need to have accumulated, how much can I withdraw annually? What are some calculators available and how to run them? What are the assumptions/shortcomings of these models?
- Comparing Equivalent ETFs – I have certain constraints in my tax-wrapper and can only select certain funds (e.g. I live in France and limited to specific synthetic ETFs). Which ETF characteristics should I pay attention to?
#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)
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#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 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).
#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 ETF SELECTION
AGGREGATE BOND ETFS
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
TREASURY BOND ETFS
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”:
Treasuries - Best Bond ETFs Links
CORPORATE BOND ETFS
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.
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.
Corporate Category - Best Bond ETFs Links
HIGH YIELD CORPORATE BOND ETFS
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 Bond ETF Category - Best Bond ETF List
High Yield Category - Best Bond ETFs Links
INFLATION PROTECTION BOND ETFS
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
TIPS - Best Bond ETFs Links
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MUNICIPAL BOND ETFS
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
Munis - Best Bond ETFs Links
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