Bond Market Index Fund

The Top 14 Low Cost Taxable United States Bond Mutual Funds (Low Minimum Deposit)

.

The top 14 low cost taxable United States bond mutual funds, when you need a low minimum deposit

This “top 10 + 4″ article discusses the top 14 low cost taxable US fixed income funds, with low minimum deposits. In this article, we consider taxable bond funds with a $10,000 maximum initial deposit for a taxable account. Required minimum deposits in the list below are $3,000 for the 13 Vanguard bond funds and $10,000 for the Fidelity fund. The primary objective of this article is to identify low cost taxable bond funds, because low investment management fees are very important when selecting fixed income funds. This article will explain why.

Now, if you are one of those high savers who has been socking money away for a long time, you might have $100,000 or more to invest in a low cost bond fund. If you have a hundred grand for a single taxable bond investment fund, then you can buy a bond mutual fund with an even lower investment management expense ratio. We have also written a United States bond article that lists the Top 11 Lowest Cost Taxable US Fixed Income Mutual Funds, if you can make the higher minimum deposit of over $100,000.

When you review the bond funds list below, you will immediately notice that, except for a single fund offered by Fidelity, every other fund is offered by The Vanguard Group mutual fund company. This is not surprising, because Vanguard’s long term business strategy has been to offer the best bond market index funds at the lowest costs. Vanguard dominates this low cost United States bond mutual funds marketplace for direct purchase accounts with both low and high minimum deposits.

What is important when you buy taxable bond funds?

Investment research overwhelmingly shows that lower cost fixed income funds tend to yield higher bond investing returns. The fixed income asset market is no place for you to try to beat the market and to attempt to get higher returns by active bond investing. Even professional fixed income asset market money managers do not beat the bond market. The higher the mutual fund company expenses, the lower the net returns to individual investors.

Professional fixed income asset market money managers do not achieve high enough returns to cover their higher fees. As a result, these higher costs cause you to get inferior net returns. You pay more. You get less.

Read this article to understand why paying higher bond mutual fund fees will most often create a “deadweight” loss for you: Bond Mutual Fund Fees. This article about the high investment management costs of fixed income funds summarizes three studies. All three of these cost evaluation studies about United States bond mutual funds clearly show that the more you pay for bond funds, the less you tend to get.

Our sister website, Best NoLoad Mutual Funds, provides an explanation of 7 factors that can help you to choose the best mutual funds and ETFs. Click any of the numbered subheadings in that article to find another article about that each selection factor for choosing bond market index funds.

Regarding choosing bond funds from a fixed income asset market mutual fund company, the process of picking fixed income funds can be even more straightforward. We also have additional articles about investing in fixed income funds and bond ETFs. These articles provide more detailed explanations of why you get less with bond funds that have higher management expense ratios. See these articles: No Load Bond Funds, Bond Mutual Fund Fees, and Bond Index Funds.

The list of the top 14 low cost taxable United States bond mutual funds with initial investments at or below $10,000

We have ordered the table of low cost United States bond mutual funds below by increasing annual management expense ratio. However, all these bond funds have management expense ratios that are very low. When investing in fixed income funds you need to decide the type of bond fund by bond quality (default risk) and bond duration. Bond duration is the weighted average of the expected cash flows for the bonds in the portfolio.

In addition to default risk and bond duration, lower bond mutual fund fees have been shown to have a significant impact on expected bond yields. Note also that the average bond duration for these bond funds will influence their rates of portfolio turnover. Over 90% of the portfolio assets of these funds are invested in bonds and fixed income securities. Most have very close to 100% of their assets in bond securities. All these funds were believed to be open to new investors at the time of writing.

While annualized 3-year investment returns are reported in the table below, it is not be appropriate to compare returns across this list of the top 14 low cost United States bond mutual funds. Due to the mixture of bond durations and other factors, this would be an apples and oranges comparison. Furthermore, the credit crunch related to the subprime mortgage crisis and the collapse of the housing bubble caused a flight to insured government bonds funds, which negatively affected prices of other noninsured bonds of varying credit quality.

The top 14 low cost United States taxable bond mutual funds with initial deposit requirements at or below $10,000

See the notes at the bottom of this table.*

#1) Vanguard Long Term Bond Index Fund - Investor Shares Class - VBLTX

Annual Management Expense Ratio _____0.18%
Annual Portfolio Turnover _____________55%
Total Portfolio Assets ($B) _____________$2.3
Annualized 3-year Investment Return ____3.5%
Taxable Account Minimum Investment ____$3,000

#2) Vanguard Short Term Bond Index Fund - Investor Shares Class - VBISX

Annual Management Expense Ratio _____0.18%
Annual Portfolio Turnover _____________106%
Total Portfolio Assets ($B) _____________$2.9
Annualized 3-year Investment Return ____5.0%
Taxable Account Minimum Investment ____$3,000

#3) Vanguard Intermediate Term Bond Index Fund - Investor Shares Class - VBIIX

Annual Management Expense Ratio _____0.18%
Annual Portfolio Turnover _____________86%
Total Portfolio Assets ($B) _____________$3.2
Annualized 3-year Investment Return ____4.8%
Taxable Account Minimum Investment ____$3,000

#4) Vanguard Short Term Federal Fund - Investor Shares Class - VSGBX

Annual Management Expense Ratio _____0.20%
Annual Portfolio Turnover _____________89%
Total Portfolio Assets ($B) _____________$1.7
Annualized 3-year Investment Return ____5.1%
Taxable Account Minimum Investment ____$3,000

#5) Vanguard Inflation-Protected Securities Fund - Investor Shares Class - VIPSX

Annual Management Expense Ratio _____0.20%
Annual Portfolio Turnover _____________53%
Total Portfolio Assets ($B) _____________$7.5
Annualized 3-year Investment Return ____5.7%
Taxable Account Minimum Investment ____$3,000

#6) Vanguard Total Bond Market Index Fund - Investor Shares Class - VBMFX

Annual Management Expense Ratio _____0.20%
Annual Portfolio Turnover _____________63%
Total Portfolio Assets ($B) _____________$30.0
Annualized 3-year Investment Return ____4.5%
Taxable Account Minimum Investment ____$3,000

#7) Fidelity Spartan Intermediate Treasury Bond Index Fund - Investor Class - FIBIX

Annual Management Expense Ratio _____0.20%
Annual Portfolio Turnover _____________100%
Total Portfolio Assets ($B) _____________$0.9
Annualized 3-year Investment Return ____Not Available (Fund is over 2 years, but not 3 years old yet. About 7% annually over 2.5 years. Be careful about apples and oranges performance comparisons. Note that at the time of writing the data for this fund indicated that it held 23% cash and 98% bonds, which implies some debt leverage in addition to long bond positions. Debt leverage can increase price volatility and risk.)
Taxable Account Minimum Investment ____$10,000

#8) Vanguard Short Term Investment Grade Fund - Investor Shares Class - VFSTX

Annual Management Expense Ratio _____0.21%
Annual Portfolio Turnover _____________43%
Total Portfolio Assets ($B) _____________$11.2
Annualized 3-year Investment Return ____4.8%
Taxable Account Minimum Investment ____$3,000

#9) Vanguard GNMA Fund - Investor Shares Class - VFIIX

Annual Management Expense Ratio _____0.21%
Annual Portfolio Turnover _____________18%
Total Portfolio Assets ($B) _____________$12.9
Annualized 3-year Investment Return ____4.7%
Taxable Account Minimum Investment ____$3,000

#10) Vanguard Intermediate Term Investment Grade Fund - Investor Shares Class - VFICX

Annual Management Expense Ratio _____0.21%
Annual Portfolio Turnover _____________43%
Total Portfolio Assets ($B) _____________$2.6
Annualized 3-year Investment Return ____4.4%
Taxable Account Minimum Investment ____$3,000

#11) Vanguard Long Term Investment Grade Fund - Investor Shares Class - VWESX

Annual Management Expense Ratio _____0.25%
Annual Portfolio Turnover _____________15%
Total Portfolio Assets ($B) _____________$4.1
Annualized 3-year Investment Return ____2.0%
Taxable Account Minimum Investment ____$3,000

#12) Vanguard High Yield Corporate Fund - Investor Shares Class - VWEHX

(See the note below.)

Annual Management Expense Ratio _____0.26%
Annual Portfolio Turnover _____________47%
Total Portfolio Assets ($B) _____________$4.6
Annualized 3-year Investment Return ____3.3%
Taxable Account Minimum Investment ____$3,000

#13) Vanguard Long Term Treasury Fund - Investor Shares Class - VUSTX

Annual Management Expense Ratio _____0.26%
Annual Portfolio Turnover _____________68%
Total Portfolio Assets ($B) _____________$1.5
Annualized 3-year Investment Return ____5.1%
Taxable Account Minimum Investment ____$3,000

#14) Vanguard Intermediate Term Treasury Fund - Investor Shares Class - VFITX

Annual Management Expense Ratio _____0.26%
Annual Portfolio Turnover _____________87%
Total Portfolio Assets ($B) _____________$2.3
Annualized 3-year Investment Return ____6.0%
Taxable Account Minimum Investment ____$3,000

Note on #12 VWEHX: This United States bond mutual funds charges a 1% fee on the sale of shares held under one year. This redemption fee is paid to the fund and benefits the fund’s remaining shareholders. Thus, it is not a back end load.

Notes about this list:
1) You can just buy index funds directly from an mutual fund company that wants direct relationships with the investing public. You do not have to waste your hard-earned money on the sales loads and 12b-1 fees that deplete your investment assets, when you buy through a financial advisor or investment counselor. Because all but one of these top 14 low cost United States bond mutual funds are offered by Vanguard, we have not provided links above to the specific funds. Instead, use these links to find these funds on the Vanguard website:

2) This list of the top 14 low cost United States bond mutual funds was developed using data base screening methods, which excluded United States bond mutual funds that did not meet the selection criteria. No analysis or due diligence of any kind was performed on any of these top 14 low cost United States bond mutual funds. This list of top 14 low cost United States bond mutual funds is solely for your information and is not investment advice or a solicitation or offer to sell securities or other financial services. There could be errors with this information, and it is your responsibility to verify all information, before you make any personal financial decision.

How this list of the top 14 low cost taxable United States bond mutual funds was developed

To develop this list we used the screening methods described below and applied them to data from early in Q1 of 2008. We have found that lists of low cost investment mutual funds and ETFs developed using these screening methods tend to be quite stable over time. Things may have changed since this article was written, and you should always verify information before investing.

The reasons are quite simple why a list like this tends to be relatively stable. If an mutual fund company competes on price, it keeps competing on price. If it offers low turnover, low fee, passively managed index mutual funds, it tends to keep offering the same.

The top 14 low cost United States bond mutual funds in the list below were selected using a process of elimination following the Best No Load Funds selection criteria. As a starting point the universe of potential United States bond mutual funds was obtained using data from Lipper and/or Morningstar. United States bond mutual funds include US Treasury, US Agency, GNMA, and corporate debt obligations - all with a range of durations and quality.

This universe of mutual funds and ETFs was then automatically screened according to these fund selection rules:

With these selection criteria, you inevitably end up with a much smaller list of mutual funds and ETFs. Remaining investment funds are almost inevitably passively managed index funds, because low cost structures cannot support the investment management activities required to pursue more risky, active strategies.

In addition, the resulting list is quite small relative to the very large universe of mutual funds and exchange traded funds that we began with. This is simply because the vast majority of investment funds are actively managed funds, which are far more likely to make money for the mutual fund company, than they are to make money for you. See this article on our sister website, The Skilled Investor, The illusion of superior professional mutual fund manager performance.

When you screen investment funds in almost any investment asset category and rank them from lower to greater investment management ratios, the resulting investment fund lists tend to be populated by funds from a handful of investment management companies. An mutual fund company sets its business strategy, and some (too few) of them have decided to compete on the basis of low costs and efficiency. These low cost investment fund companies tend to do a better job of serving the interests of individual investors.

Tags: , , , , , , , , ,

Top 11 Low Cost US Taxable Fixed Income Mutual Funds (High Minimum Deposit)

The top 11 low cost taxable U.S. fixed income mutual funds, when you have $100,000 to invest

This “top 10 + 1″ article discusses the top 11 low cost US taxable bond mutual funds, if you have $100,000 to invest. Now, you say that you do not have a hundred grand for a single bond market investment fund? Well, all is not lost for you (and for most other people). Elsewhere on this bond index funds website, we have published a US bond article that lists the Top 14 Low Cost Taxable US Bond Mutual Funds that have much lower initial contribution requirements. This other taxable US bond article covers taxable US fixed income mutual funds that require much lower initial investments for taxable fixed income funds.

When you review the taxable fixed income funds list below, you will immediately notice that every fund is offered by The Vanguard Group investment company. This is not surprising, because Vanguard’s long term business strategy has been to offer the best index mutual funds at the lowest costs. Vanguard dominates this low cost US fixed income mutual funds marketplace.

What is important when you buy taxable fixed income funds?

Most importantly, the investment research literature indicates that lower cost bond mutual funds tend to yield higher fixed income investing returns. The bond market is no place for an individual investor to try to beat the market and get higher returns through attempts at clever fixed income investing. Even professional bond market money managers do not beat the bond market. The higher their fund charges, the further they fall behind.

The failure of professional bond market money managers to deliver higher returns to justify their higher fees is thoroughly documented in the research literature. To better understand why paying higher bond mutual fund fees creates a “deadweight” loss to individual investors, see this Bond Mutual Fund Fees article elsewhere on this website. This article about the unjustifiably high investment management costs of bond mutual funds summarizes three studies. All three of these cost evaluation studies about US fixed income mutual funds clearly show that the more you pay for fixed income funds, the less you get.

Our sister website, Best NoLoad Mutual Funds, provides some scientific criteria for selecting the best mutual funds and ETFs. Click any of the numbered subheadings in that article, and you will find a more detailed article about that particular selection criteria for choosing index mutual funds.

Regarding selecting fixed income funds from a bond market investment company, the process of choosing bond mutual funds can be even more straightforward. On this website, you will find additional articles about investing in bond mutual funds and bond ETFs. These articles indicate that the more you pay when you buy fixed income funds, the less you get. See these articles: No Load Bond Funds, Bond Mutual Fund Fees, and Bond Index Funds.

The list of the top 11 low cost taxable US fixed income mutual funds, when you have $100,000 to invest

The table of low cost taxable US fixed income mutual funds below is arranged by increasing annual management expense ratio. However, all these fixed income funds have management expense ratios that are very low. When investing in bond mutual funds you need to decide the type of bond fund by bond quality (default risk) and bond duration. Bond duration is the weighted average of the expected cash flows for the bonds in the portfolio.

In addition to default risk and bond duration, lower bond mutual fund fees have been shown to have a significant impact on expected bond yields. Note also that the average bond duration for these fixed income funds will influence their rates of portfolio turnover. Over 90% of the bond portfolio assets of these funds invested in bonds and fixed income securities. Most have very close to 100% of their assets in long bond secuities. All these funds were believed to be open to new investors at the time of writing.

While annualized 3-year investment returns are reported in the table below, it would not be appropriate to compare returns across this list of the top 11 low cost US fixed income mutual funds. Such a comparison would be an apples and oranges comparison, due to the mixture of bond durations and other factors. Furthermore, the credit crunch related to the subprime mortgage crisis and the collapse of the housing bubble caused a flight to insured government bonds funds, which negatively affected prices of other noninsured bonds of varying credit quality.

See the notes at the bottom of this table.*

#1) Vanguard Long Term Treasury Fund - Admiral Share Class - VUSUX

Annual Management Expense Ratio _____0.10%
Annual Portfolio Turnover _____________68%
Total Portfolio Assets ($B) _____________$1.2
Annualized 3-year Investment Return ____5.3%
Taxable Account Minimum Investment ____$100,000

#2) Vanguard Short Term Federal Fund - Admiral Share Class - VSGDX

Annual Management Expense Ratio _____0.10%
Annual Portfolio Turnover _____________89%
Total Portfolio Assets ($B) _____________$1.3
Annualized 3-year Investment Return ____5.2%
Taxable Account Minimum Investment ____$100,000

#3) Vanguard Short Term Investment Grade - Admiral Share Class - VFSUX

Annual Management Expense Ratio _____0.10%
Annual Portfolio Turnover _____________43%
Total Portfolio Assets ($B) _____________$8.4
Annualized 3-year Investment Return ____4.9%
Taxable Account Minimum Investment ____$100,000

#4) Vanguard Intermediate Term Treasury Fund - Admiral Share Class - VFIUX

Annual Management Expense Ratio _____0.10%
Annual Portfolio Turnover _____________87%
Total Portfolio Assets ($B) _____________$3.2
Annualized 3-year Investment Return ____6.2%
Taxable Account Minimum Investment ____$100,000

#5) Vanguard Intermediate Term Investment Grade - Admiral Share Class - VFIDX

Annual Management Expense Ratio _____0.10%
Annual Portfolio Turnover _____________43%
Total Portfolio Assets ($B) _____________$3.5
Annualized 3-year Investment Return ____4.5%
Taxable Account Minimum Investment ____$100,000

#6) Vanguard GNMA Fund - Admiral Share Class - VFIJX

Annual Management Expense Ratio _____0.11%
Annual Portfolio Turnover _____________18%
Total Portfolio Assets ($B) _____________$11.0
Annualized 3-year Investment Return ____4.8%
Taxable Account Minimum Investment ____$100,000

#7) Vanguard Total Bond Market Index Fund - Admiral Share Class - VBTLX

Annual Management Expense Ratio _____0.11%
Annual Portfolio Turnover _____________63%
Total Portfolio Assets ($B) _____________$10.8
Annualized 3-year Investment Return ____4.6%
Taxable Account Minimum Investment ____$100,000

#8) Vanguard Short-Term Bond Index Fund - Admiral Share Class - VBIRX

Annual Management Expense Ratio _____0.11%
Annual Portfolio Turnover _____________106%
Total Portfolio Assets ($B) _____________$1.6
Annualized 3-year Investment Return ____5.1%
Taxable Account Minimum Investment ____$100,000

#9) Vanguard Intermediate Term Bond Index Fund - Admiral Share Class - VBILX

Annual Management Expense Ratio _____0.11%
Annual Portfolio Turnover _____________86%
Total Portfolio Assets ($B) _____________$2.4
Annualized 3-year Investment Return ____4.9%
Taxable Account Minimum Investment ____$100,000

#10) Vanguard Long Term Investment Grade Fund - Admiral Share Class - VWETX

Annual Management Expense Ratio _____0.12%
Annual Portfolio Turnover _____________15%
Total Portfolio Assets ($B) _____________$1.6
Annualized 3-year Investment Return ____2.1%
Taxable Account Minimum Investment ____$100,000

#11) Vanguard High Yield Corporate Fund - Admiral Share Class - VWEAX

(see note below)

Annual Management Expense Ratio _____0.13%
Annual Portfolio Turnover _____________47%
Total Portfolio Assets ($B) _____________$4.3
Annualized 3-year Investment Return ____3.4%
Taxable Account Minimum Investment ____$100,000

Note on #11 VWEAX: This US fixed income mutual funds charges a 1% redemption fee on the sale of shares held under one year. This redemption fee is paid to the fund’s remaining shareholders, and thus it is not a back end load.

Notes about this list:
1) You can just buy index funds directly from an investment company that wants direct relationships with the investing public. You do not have to waste your hard-earned money on the sales loads and 12b-1 fees that deplete your investment assets, when you buy through a financial advisor or investment counselor. Because all of these top 11 low cost US fixed income mutual funds are offered by Vanguard, we have not provided links above to the specific funds. Instead, use these links to find these funds on the Vanguard website:

2) This list of the top 11 low cost US fixed income mutual funds was developed using data base screening methods, which excluded US fixed income mutual funds that did not meet the selection criteria. No analysis or due diligence of any kind was performed on any of these top 11 low cost US fixed income mutual funds. This list of top 11 low cost US fixed income mutual funds is solely for your information and is not investment advice or a solicitation or offer to sell securities or other financial services. There could be errors with this information, and it is your responsibility to verify all information, before you make any personal financial decision.

How this list of the top 11 low cost taxable US fixed income mutual funds was developed

To develop this list we used the screening methods described below and applied them to data from early in Q1 of 2008. We have found that lists of low cost investment mutual funds and ETFs developed using these screening methods tend to be quite stable over time. Things may have changed since this article was written, and you should always verify information before investing.

The reasons are quite simple why a list like this tends to be relatively stable. If an investment company competes on price, it keeps competing on price. If it offers low turnover, low fee, passively managed index mutual funds, it tends to keep offering the same.

The top 11 low cost US fixed income mutual funds in the list below were selected using a process of elimination following the Best No Load Funds selection criteria. As a starting point the universe of potential US fixed income mutual funds was obtained using data from Lipper and/or Morningstar. US fixed income mutual funds include US Treasury, US Agency, GNMA, and corporate debt obligations - all with a range of durations and quality.

This universe of mutual funds and ETFs was then automatically screened according to these fund selection rules:

With these selection criteria, you inevitably end up with a much smaller list of mutual funds and ETFs. Remaining investment funds are almost inevitably passively managed index funds, because low cost structures cannot support the investment management activities required to pursue more risky, active strategies.

In addition, the resulting list is quite small relative to the very large universe of mutual funds and exchange traded funds that we began with. This is simply because the vast majority of investment funds are actively managed funds, which are far more likely to make money for the investment company, than they are to make money for you. See this article on our sister website, The Skilled Investor, The illusion of superior professional mutual fund manager performance.

When you screen investment funds in almost any investment asset category and rank them from lower to greater investment management ratios, the resulting investment fund lists tend to be populated by funds from a handful of investment management companies. An investment company sets its business strategy, and some (too few) of them have decided to compete on the basis of low costs and efficiency. These low cost investment fund companies tend to do a better job of serving the interests of individual investors.

Tags: , , , , , , , , ,

No Load Bond Funds

High costs lead to inferior bond mutual fund performance

Bond portfolio management is a relatively specialized fixed income securities activity. You might expect that certain bond mutual fund managers would be more skilled than others and would produce higher bond returns. Better performance due to investment skill could, of course, justify paying extra fees.

However, investment science has not detected a relationship between paying higher fees and obtaining better returns from the bond mutual fund industry. In fact, the opposite seems to be true. Higher expenses tend to mean lower net returns to individual investors. [See: Bond Mutual Fund Fees]

While different from the equity markets, the bond markets also tend to be relatively efficient from the standpoint of reflecting currently available information in prices. They are simply not easy to beat in the sense that it is difficult or impossible to detect and capitalize on mis-pricing. Nevertheless, transactions or trading fees are relatively high — especially for individual investors purchasing fixed income securities instead of fixed income investment funds. [See: Bond Market Index Funds]

Buy no load bond funds to get the best bond fund performance

Once an individual investor has decided to purchase shares in a bond mutual fund, the selection process can be relatively straightforward. Bond mutual funds are just another financial product being marketed to fill an investment need. The fund companies that offer them make decisions on how they will compete – whether through advertising, agents, service, word-of-mouth, etc. Some fixed income funds compete on price, i.e. lower fees, and others do not. Patronize funds that compete on price, that is, they offer rock bottom management expense ratios.

To protect your interests – instead of the interests of the mutual fund companies – you need simply to determine the style of fund you desire in terms of bond maturity and investment quality. Then, from among the funds with the lowest fees, just pick one or preferably several bond mutual funds — several for greater investment diversification — that are offered by reputable firms. If you pay higher fees, you will most likely just throw your money down a securities industry profit hole.

Just say NO to bond fund sales loads

If you are dealing with any investment counselor or financial advisor who tries to promote a bond market mutual fund with high fees and/or a bond mutual fund with a front-end load, just say no. Investment science indicates that there is no justification for paying higher expenses or a front-end load. Higher sales load expenses just tend to lower your total returns.

A front-end load just means that you are paying someone to sell you an investment. Paying extra to be sold to is hard to justify in any type of business transaction – whether in investments or in any other industry. It is easy to buy directly from bond market mutual funds and cut out the intermediary. Fixed income fund families that want your direct business all have how-to-buy information on their websites and toll free customer service telephone numbers.

Sales loads are an extremely expensive way to pay a financial advisor. If you need a financial advisor, find one who accepts hourly or fixed fee compensation and does not take any commission money from the industry through the “back door.” Also, if your financial adviser pushes fixed income investment funds with high expense ratios, this is an indication that they have not done their homework. Either that or they care more about their own compensation than they do about your financial outlook. Get a better financial advisor who will look out for your interests and save you money over the long haul.

Fixed income fund redemption fees

In addition, note that there can be a reasonable justification to pay a short-term, back-end redemption charge. If a fund has a longer average maturity and wishes to discourage shorter-term trading behavior, a redemption charge could be assessed for some limited period following a purchase to protect longer-term fund holders.

A short-term redemption charge is not a back-end load. Back-end loads pay bond financial advisors, investment counselors, and their firms. Instead, redemption charges are paid (or should be - check to find out) to the shareholders of the fund. Redemption fees should be designed to compensate long-term shareholders for any higher trading costs and/or higher short-term capital gains taxes caused by short-term share trading.

If a fund has such a redemption fee and you agree with why it is there, then you should confirm that all such fees collected are returned to the fund itself solely for the benefit of fund investors who stay in the fund for a longer period. In addition, of course, you need to make sure that it is highly unlikely that you will need to redeem your investment within this penalty window.

Note also that some very low cost no load bond market index funds may have longer-term back end redemption fees that are paid to remaining shareholders and only expire after multiple years. This is a clear signal that the fund is designed for both cost efficiency and long-term investors. A modest multi-year redemption fee (perhaps 1% or less paid upon exit before some number of years) might not be a bad idea for very low cost no load bond funds.

With a stay put, buy-and-hold shareholder clientele, you could benefit from very low annual costs, very low portfolio turnover and trading costs, and redemption fee “protection” from frequent early exits and churning by those with a short-term trading perspective. Again, consider the likelihood of you being a long-term holder who would benefit from others who exit early, versus you needing to exit early and pay the redemption fee yourself.

Tags: , , , ,

Bond Index Funds

Invest in fixed income securities only through low cost bond market index funds

Bond trading is a very complex process that individual investors should leave to professional fund managers. The pricing and trading of bonds and fixed income securities is far more convoluted than for common stocks or equities. Furthermore, bond pricing is much less transparent and has wide spreads. In a very real sense, you buy at retail prices and sell at wholesale prices.

Securities pricing in the bond market is much different from the stock market. While a firm usually has only one kind of common stock, it could have dozens or even hundreds of different outstanding fixed income securities. Few individual investors have the required skill, knowledge, information, and experience to assess bond market prices.

Fixed income securities or bonds have different valuation characteristics than do common stock securities, and bonds require different valuation methods. Common stock investments give the investor a claim to part of the market value of the firm and to its dividends, if the Board of Directors declares any such payments.

Compared to common stock held by shareholders, corporate bonds give their holders a more senior claim to the firm’s cash flow to pay bond interest and principal payments. If bondholders’ claims cannot be met, then default and bankruptcy may occur. The firm could be forced to sell or liquidate, and equity ownership could pass to its creditors and bondholders. Such events are usually very difficult, slow, and distasteful processes.

Figuring out whether bond obligations are likely to be fulfilled by issuers during the term of the bond is best left to professional bond investment specialists. This is called the default risk. Expectations about the varying potential for default can cause substantial price differences for bonds that otherwise have similar terms.

Investors can achieve higher returns by choosing the lowest cost bond market index funds

No load bond funds also can also provide a very high degree of fixed income securities investment diversification, and no load mutual funds can do this very economically. For individual investors it simply is much more straightforward to hold bonds through a bond fund.

Once a bond fund establishes its “style” for the type, maturity, and quality of bonds it will hold, it purchases and holds bonds with an eye toward maintaining that style. Maintaining targeted maturity is relatively straightforward. Determining investment quality is less straightforward, but bond mutual funds have analysts on staff and have access to the analytic services of bond ratings houses like Moody’s, Standard and Poor’s, and Fitch Ratings.

Bond market index funds offer a far higher degree of investment portfolio diversification

No load bond funds provide the investment risk reduction associated with market diversification. Investors can achieve fixed income securities diversification far more economically than they could through the direct purchase of individual bonds.

Fixed income mutual funds offer additional trading efficiency advantages to individual investors. The professional traders of bond mutual funds can conduct fixed income securities trading much more efficiently. Furthermore, fixed income funds trade substantial volume, which gives them leverage in negotiations and the ability to trade with different partiesthe. Individual investors have no such leverage, and they must take or leave the price they are given. Therefore, individuals buy at retail prices and sell at wholesale prices — often paying substantially higher spreads than professional fixed income securities traders do.

Without knowing it, bond market trading of individual fixed income securities can be very expensive for individual investors. Individual investors simply cannot tell whether they are getting a fair market price. Sometimes, individual investors pay very high spreads and transaction expenses, when they buy or sell individual bond securities. This is not an issue of bond market inefficiency. Rather, it is a problem of grossly unfair treatment aided to the obscurity of the bond market pricing process and the willingness of certain traders to take full advantage of individual investors.

Tags: , , , ,

Bond Mutual Fund Fees

Is it worth paying higher bond mutual fund management fees?

Simply put, if you pay higher bond mutual fund fees, then these bond management expenses tend just to be a “deadweight” loss to you. The best bond fund buying strategy is to pick only very low-cost no load bond funds.

In pursuit of higher risk-adjusted bond mutual fund returns, many investors wonder whether it is worth paying higher expenses and fees. If they do pay more, will they get better mutual fund performance? Will higher performance outweight the added expenses? Investment science provides a strong “no” as the answer. When you pay more in bond mutual fund fees, you are just wasting your money.

Higher bond mutual fund fees hurt the performance of all types of fixed income funds

In “Bond Fund Returns and Expenses: A Study of Bond Market Efficiency,” Professor William Reichenstein of Baylor University studied the relationship between bond mutual fund returns and expenses.1 Professor Reichenstein analyzed bond mutual fund expenses and returns for the years 1994 to 1998.

To ensure that he was comparing bond funds of similar characteristics, Professor Reichenstein grouped bond mutual funds by their investment styles. Fund groups were differentiated by maturity (short-, medium-, long-term maturities) and investment grade quality (low, medium, high quality). Within each of the nine combinations of these maturity and quality style groups, he assigned each individual fixed income fund to one of three equal sized groups according to the fund’s expense ratio (low, medium, high expenses).

Professor Reichenstein tested several theories about investment returns and expenses over 1-year, 3-year, and 5-year time horizons by comparing average investment returns between these nine maturity and quality groupings. For example, he compared the average net return of the low cost group to the medium cost and the high cost groups of the same style to see whether higher fees produced greater returns, and so on. Without failure, Professor Reichenstein found that higher expenses predicted lower returns in 42 out of the 42 group comparisons.

Professor Reichenstein cited other studies of fixed income mutual funds expense and return averages that yielded similar results. For example, Jonathan Clements used Morningstar data that grouped bonds into five categories: government backed mortgage, corporate, U.S. Treasury, general municipal, and high-yield bonds.2 Clements found that in 28 out of 30 comparisons higher expenses meant lower returns to the investor. In 1999, Clements updated his 1991 study and found that higher expenses still meant lower returns to the investor, this time in 15 out of 15 cases.3

Again, higher bond mutual fund expenses lead to lower bond mutual fund performance

In addition, in 1999 John Bogle analyzed bond maturity and quality groupings for government, corporate, and municipal funds.4 He found that in 24 out of 24 comparisons higher expenses meant lower returns. In summary, 109 of the 111 comparisons in these four studies indicated that higher average expenses meant lower returns to investors.

Superior performance of specific bond mutual funds could have been obscured by comparing only the averages between groups. Therefore, Professor Reichenstein tested whether individual funds within his maturity and quality groupings delivered returns that compensated for their higher expenses. Again, his conclusion was no.

In fact, his analysis indicated that higher bond mutual fund expenses were a dollar for dollar “deadweight loss.” The higher the expenses, the lower the net return was for the individual investor. Professor Reichenstein’s analysis also concluded that the performance of similar bond funds with and without front-end loads was not statistically distinguishable. Additional expenses and investment broker sales loads just tended to result in a dollar-for-dollar reduction in investor’s assets.

Pay more to get less. Hmmmmm… Since when is that at good idea? Save your money. Ignore what commissioned bond mutual fund brokers and investment counselors tell you. Higher costs and sales loads to not deliver better bond mutual funds. Seek out and buy low cost, no load bond funds. Buy them directly from the mutual fund company to save money. It is your money. Hold on to it!

Footnotes:

1) Reichenstein, William. “Bond Fund Returns and Expenses: A Study of Bond Market Efficiency.” Journal of Investing, Winter 1999: 1-9
2) Clements, Jonathan. “In Picking Bond Fund, Expense Factor Remains the Key.” Wall Street Journal, April 4, 1991, p. C1.
3) Clements, Jonathan. “If Your Manager is So Smart, Why are his Expenses So High?” Wall Street Journal, July 6, 1999, p. R1.
4) Bogle, John, C. Bogle on Mutual Funds: New Perspectives for the Intelligent Investor. Burr Ridge, Il: Irwin, 1994

Tags: , , ,